In this episode of McKinsey Talks Operations, host Daphne Luchtenberg sits down with senior partners Axel Karlsson and Daniel Swan to explore the impact of an evolving economic landscape on organizations. Discover how they are adapting to unprecedented challenges, from inflation to sustainability, and why operations and supply chains are taking center stage in the boardroom.
This conversation has been edited for clarity. Statistics correct at the time of recording in August 2023.
Daphne Luchtenberg: What are the three things companies should be thinking about when it comes to their operations agendas?
Axel Karlsson: Number one, how to apply generative AI and automation to the back-office and shared-service functions. Number two, purchasing under inflationary circumstances; there are huge gains to be had quickly if you navigate this space. And third, sustainability. In operations, we’ve long been optimizing for efficiency, quality, and cost. Now, it’s also about sustainability and carbon footprint.
Daphne Luchtenberg: That was Axel Karlsson, and you’re listening to McKinsey Talks Operations.
Your company’s future success demands agile, flexible, and resilient operations. I’m your host, Daphne Luchtenberg, and you’re listening to McKinsey Talks Operations, a podcast where the world’s C-suite leaders and McKinsey experts cut through the noise and uncover how to create a new operational reality.
As leaders turn their attention to planning for 2024, we wanted to take a moment to look at the global landscape and explore some of the key questions and pressing issues impacting companies, as well as look at what they should be doing to optimize their operations around the world. This moment provides an opportunity for big changes and bigger value capture, and it requires a commitment from the very top of the organization. Joining us to explore some of these hot topics are Daniel Swan and Axel Karlsson, senior partners and global co-conveners of McKinsey’s Operations Practice. Thank you both very much for being here. Dan, welcome.
Daniel Swan: Thank you, Daphne. Looking forward to the discussion.
Daphne Luchtenberg: Axel, great to see you here as well.
Axel Karlsson: Great to see you, too. Thank you so much for having us.
Daphne Luchtenberg: Let’s kick off the conversation and start with the big picture. Dan, can I start with you first? With your view on the North American markets, how are you seeing volatility evolve?
Daniel Swan: There’s certainly a lot happening today, and I think it puts a lot of different demands on supply chain and operations organizations to solve a complex equation. Our inflationary environment over the past few years has changed a situation where operations and productivity programs could offset inflation into one where that’s practically impossible when you’re talking about 7 to 10 percent inflation year over year, as we’ve seen in recent years. It really puts an increasing demand on supply chains and organizations to deliver productivity.
I think the second thing we’re seeing is that supply chain executives are also being asked to deliver on sustainability and to help improve the carbon footprint and reduce the impact on our environment. And they’re also being asked to increase the resiliency of their operations coming out of a global pandemic, not to mention the many other disruptions we’ve had. So when you look at the macroenvironment around these organizations, and what so many of our clients are facing, it really is a unique environment that requires both understanding the trade-offs across all these different dimensions, as well as delivering results across multiple fronts.
Daphne Luchtenberg: Axel, let me invite you in here.
Axel Karlsson: In Europe, we see quite different dynamics and different industry sectors. So I think everything that has to do with consumer-facing industries is relatively weak, driven by the consumer simply having less money to spend and Europe being quite affected by high interest rates. At the same time, we have other industry sectors that are booming. If you look at the green-energy transition and battery factories, there are many examples where it’s never been better than it is right now. So the combination is an unusual one. I would say in both of these extremes, operations has never been higher on the CEO agenda.
And we’re also seeing some dynamics that we haven’t seen for a generation, like purchasing in such an inflationary environment. We have had 25 to 30 years since we saw something similar. So the capabilities needed to purchase the tools are quite different from what we’ve seen for a while. We also have new technological opportunities, opening up brand-new opportunities to restructure back-office and such functions. And given the macroeconomics, tying back to that, I think the urge to move has never been bigger among our clients. And it’s not just a COO topic; it’s really a CEO topic.
Daphne Luchtenberg: Let’s move on then. As you’re having conversations with clients, there are some really important trade-offs to make. Where are clients placing their big bets?
Daniel Swan: Great question, Daphne. I think in the world we seem to be operating in, the reality is that for a lot of operations leaders, productivity is a nonnegotiable, right? It’s just the reality of where we sit and the reality of the cost pressures a lot of people have faced—whether you’re a product manufacturer and input costs and raw materials or whether you’re a services company, you’ve seen the cost of labor grow meaningfully. The need to drive productivity has never been higher. So I would say for most of our clients and companies, that’s kind of a nonnegotiable. Then what we see on top of that is a lot of supply chain leaders and executives thinking really hard about where they’re going to make their big bets.
For example, resiliency and how to build in more operational flexibility were supercritical capabilities that were front and center for everybody over the last couple of years. But the question is, how much will companies invest in that supply chain and operational resiliency as we return to something that feels more normal? And will the importance there continue to be as high as it has been the past couple of years? While we can’t predict what the next disruption will be, we are quite confident that there are more and more disruptions coming down the pike.
On the sustainability front, we’ve also got to tackle head on where the emissions sit today. A lot of companies are heavy emitters, and a lot of that is upstream from their individual supply chains, so they are having to place big bets on how they can improve impact and the environment through their operations. And some of those things actually reduce costs, which is a very good thing. Others potentially require investment.
Daphne Luchtenberg: And presumably, navigating the volatility in labor availability is another critical factor there.
Daniel Swan: Three or four years ago, automation was a four-letter word, particularly in the US. It was going to disrupt our economy and cause real challenges. Now, there are nearly a million manufacturing jobs open in the US. And that’s before we add the billions and billions of dollars of investment that will come from IRA [Inflation Reduction Act], the CHIPS [and Science] Act, and the [Bipartisan] Infrastructure Law that the US government has passed. When you look at that, the increasing demand for manufacturing jobs, construction jobs, etcetera, is going to put real strains on our ability to fill them and, therefore, produce the products we need to make and get the jobs done that need to get done.
So I think we’ve potentially reached an inflection point where automation has gone from being a bad word to potentially being a savior for how we get the work done.
Axel Karlsson: I think there’s an interesting phenomenon: the capital intensity in the world is seemingly going up, driven by a number of megatrends. We touched upon electrification, battery factories being built, the electric grid needing to be rebuilt, and more power generation needed in Europe. There’s a huge need for infrastructure investment, and infrastructure investment is going up. So any type of capital intensity is increasing, also driven by IT and different digital innovations that also require investment.
Therefore, I think capital excellence, or how to deal with large capital-consuming projects in an efficient way, is also a theme for us in our client service that is seeing increased traction. I think this trend will probably become more prominent in the next 15 to 20 years. It’s also important to think about what this will mean for economic policy in the coming years, what it will mean for inflation, and how the fundamental economic forces will change in the coming 20 years compared with the previous 20.
Daphne Luchtenberg: And actually, as we build on that, Axel, if you’re thinking about just the fundamentals of operational excellence, COOs cut their teeth on the Lean methodologies, and we’re seeing that back-to-basics approach happening now, but enhanced with technology and thinking differently, holistically, about purpose and how people are involved in delivering excellence.
Axel Karlsson: Our practice was initially founded on the Lean principles, and for many years, the vast majority of the work we did was around Lean methodologies. I think over the past 15 years or so, we’ve seen a shift from classical Lean toward more technology-driven operations of various forms. I would still say that for those of us who remember the old Lean principles, they still apply. It’s now evolved into different types of Lean—it’s morphed into new shapes. As a result, most of our clients are pretty good at doing it. Now our clients are thinking more about the next wave of Lean and digital manufacturing and leveraging the latest procurement tools in digital.
We already spoke about service operations, automation, and what generative AI can mean for that. All of this is, of course, based on Lean principles, but it’s really the technology-enabled, next-generation version of that. And I think the macroeconomic environment that we started talking about is driving a much faster adoption of these new technologies and new practices with our clients.
Daphne Luchtenberg: You both talked a bit about how operations is now absolutely a CEO topic. Dan, can you say some words about that dynamic changing, and how are CEOs engaging with some of these typical operations topics?
Daniel Swan: One of the things that’s kind of an adage in operations and supply chain is that you only get called to the front when something’s gone wrong. For a lot of people, things went wrong and were very challenging over the last couple of years. I do think, naturally, it has become more of a board- and a CEO-level topic. And I think there are a couple of big things behind that.
One is obviously, with some of the major disruptions we had, it was impossible to run your supply chain. And one of the things I think has been lost in the discussion around the supply chain disruptions over the past couple of years is the crazy spikes in demand that we saw in different industries.
The second is this led to some challenging conversations and big strategic discussions. Early on in the pandemic, what we found in all of our surveys was that people were basically trying to increase inventory, and that’s fine. You can do that in relatively short order, etcetera. But as we’ve seen it evolve over the past couple of years—and it’s not just been the pandemic; there’s been the war in Ukraine and all these other disruptions—all of a sudden people are saying, “Should we be doing more nearshoring or reshoring and doing more production closer to the consumer? Should we be rethinking our talent profile? And are we overconcentrated in certain countries around the world? Should we be thinking about changing the specifications of our product?”
A lot of those things led to really strategic, important discussions that brought supply chain to the forefront of not just the CEO and the executive room, but the boardroom as well.
Daphne Luchtenberg: So, Axel, have you seen a shift in the discourse happening at the boardroom table?
Axel Karlsson: Oh, absolutely. I think it’s a record time for the amount of different operations-related topics that reaches the board. Manufacturing and supply chain footprint has been a huge topic, given political tensions, and increased supply chain resiliency needs to be more focused than it was ten years ago. Sustainability is also a key consideration. A certain supplier of nickel can be thousands of times more environmentally hazardous than another supplier of the same metal. So your supplier selection matters greatly from a sustainability point of view. That’s also on the board agenda.
Then operations, of course, is on the agenda. How do you save money? We have a shortage of some professions, so we can’t hire for some jobs. Why do we have unemployment in other areas? There’s just a record number of very different operations topics that all reach a CEO or reach a board. And then prioritizing where we start, and how we make sense of this is, of course, much more difficult now than it ever has been before.
Daphne Luchtenberg: And of course, part of that is around transparency, data information, and having that at your fingertips at a much faster pace. Which is presumably an opportunity for the technology and the innovations that are coming down the pike and then also, potentially, the impact of generative AI.
Axel Karlsson: The opportunities, leveraging data on digital across the operations space, are more or less infinite. We’ve seen it for a decade or more in digital manufacturing and in various next-generation digital applications. But now, we are expecting a new S-curve driven by generative AI. You can see applications of generative AI in most areas within operations. I think the shift will be almost as big as when the computer hit the desk in the office: what you can do, how it will change clients, how it will change the software industry, and how it will change customer service. It will be a big new revolution.
But to benefit from that, you need to have your data strategies well sorted. You need to have control of what data you are accessing, should be accessing, and should be leveraging to make your corporation even better.
Daphne Luchtenberg: And within that, the CTO [chief technology officer] and the COO have to be in lockstep right?
Daniel Swan: When you look backward at some of the technology implementations within operations, one of the failure modes you see is that sometimes the CTO and the head of operations or the head of the supply chain weren’t in lockstep. So what you end up with is a tool implementation that hasn’t reaped the benefits or had the impact that one might hope. We see this all the time, whether in advanced planning or technology implementations or whether we see it with more source-to-pay in the procurement arena, where people have put the tool in but haven’t gotten the value.
So the idea of being super clear on the business case, understanding where the impact comes from, and also recognizing the nontechnological factors that are required to deliver the impact are crucial. For example, how do you build the capabilities of your organization to actually use the tool? How do we put the right performance management and metrics in place to measure how we’re doing, both in terms of compliance with tool usage and the outputs? As these technologies get better, and as people get clearer on what it requires to deliver impact, the CTO and the CEO will need to be in lockstep.
The other way we need to look at it is for each area where you’re trying to improve your business, what’s the full potential of the technology in generative AI? We should never do a planning transformation that isn’t really looking across how do you prove the process and the capabilities of the people? How do you leverage traditional technology, such as an advanced-planning system? And how do you leverage generative AI, etcetera? So not only should we be looking at it as generative AI end-to-end across your company, but we should be asking the question, “For each business problem, what full suite of tools, including the more advanced technologies, do we have to solve that problem? And that’s a learning and an adaptation for people across a lot of client organizations.
Daphne Luchtenberg: That’s really helpful. There’s been a lot of learning, as you say, so the playbook is emerging. It’s not like people are moving without knowing the steps to take. Axel, I know we’ve been working on the Global Lighthouse Network with the World Economic Forum, and it’s encouraging to see the number of lighthouses being called out; they’re growing each year.
Axel Karlsson: This is super exciting. We’ve worked together with the World Economic Forum now for quite a while, and we’ve been able to generate several lighthouses proving the latest and greatest in different operations technologies—most notably, various types of digital manufacturing or digital tools, generating results that bring them to the top of the top in their respective industries. For any interested listener, you can check out [lighthouses] on the web; they are quite interesting. Speaking of the impact and common thread across those cases, I believe the key concept is value. I think that’s an evergreen topic, something every operations leader needs to bring with them. All these lighthouses began by identifying the applications for new technologies within operations that can bring them the biggest value. Then within those areas, how do we apply the technology in the most efficient way and get the most bang for the buck? Then actually do it so you have a proof point—a lighthouse—to show that it can be done, and you can prove the impact with it.
This staging, starting value back, and then deciding which technology to apply sounds very simple. But actually, very few do that. We all have a tendency to go with the latest trend and get excited about some tool and then invest many millions of dollars in applying various tools without always getting the value for it.
Daniel Swan: One of the things that’s been really interesting is making sure companies are thinking about scaling the impact from these use cases and the digital journeys from the very beginning. In the good old days, people would try something, see if it worked, then have the proof point, and then think about how they scale it. Well the reality is, what you need to do to scale it could be very different from what you need to do to prove that it works the first time.
We see a lot of leading companies changing their mindset of trying to figure it out in one place. And not only [are they] doing that, but also they’re thinking what are the things that I need to put in place so I can scale this across my entire network from the beginning, and that is a massive shift in thinking.
Daphne Luchtenberg: Beautifully said. We’re going to have to conclude the conversation, but it’s been super interesting. As CxOs [chief experience officers] and the boardroom are thinking about their planning for 2024 and the opportunities, but also the challenges that need to be navigated, what are the three things they should be thinking about when it comes to their operations agenda, Axel?
Axel Karlsson: I would say number one, how to apply generative AI and automation to the back-office and shared-service functions; there’s a huge opportunity for every company I know of regardless of industry. Number two, purchasing under inflationary circumstances; there are huge gains to be had quickly if you navigate this space. It has been a long time since we faced a similar environment. So most people in the purchasing department are not up to speed with what can be done. And third, sustainability in operations. In operations, we’ve long been optimizing for efficiency, quality, and cost. Now it’s also about sustainability and carbon footprint. There are many methodologies to do both at the same time, and you can make money from that.
Daphne Luchtenberg: Thanks. And Dan, how about you?
Daniel Swan: I’ll have just three things I think we should be encouraging around the mindset of our CEOs and senior operations executives. One is, while I think a lot of our clients feel enormous pressure to deliver productivity in this environment, I would encourage people to use this environment as a chance to change the mindset around productivity within your organizations.
There’s never been a better opportunity to get heads of marketing, CFOs, and heads of sales focused on productivity to tackle some of the things that an operations executive can’t do on their own, but that require collaboration with others. The second thing I would think about is, how do we infuse technology enablement into everything we do from an operations perspective and have it not be a tech agenda versus an operations agenda—but bring those two things together?
And the third mindset I encourage people to have is, how do we ensure that supply chains and operations remain a boardroom topic and a CEO priority? As we return to something that feels more “normal”—I’m not sure any of us know what normal means anymore— this has been a unique time where operations and supply chains have moved into the boardroom, and I think that’s a really good thing. It’s especially good for companies to have more boards and CEOs thinking about supply chains and operations every day.
Daphne Luchtenberg: That’s wonderfully said. Thanks so much for joining us for this conversation. Axel, thanks so much for being here. It was great to have you.
Axel Karlsson: Thank you for having me, Daphne.
Daphne Luchtenberg: Dan, thanks for sharing your perspectives and being part of this conversation today.
Daniel Swan: Thanks a lot for having me, Daphne. I really enjoyed it.
Daphne Luchtenberg: You’ve been listening to McKinsey Talks Operations with me, Daphne Luchtenberg. If you like what you’ve heard, make sure to subscribe and stay tuned.