Indirect manufacturing costs hold potential for higher savings

For companies seeking better ways to lower their costs, one strategy often overlooked but having a strong potential is optimizing indirect manufacturing functions for enhanced resilience and clear savings, according to a new report.

As inflation expands the cost of materials, services, and labor, enterprises can trim costs and improve their resiliency by standardizing indirect operations to make these more efficient and streamlined, according to global management consulting firm McKinsey & Company.

Indirect operation functions contribute a significant share of total operations resourcing—between 8% and 12% of total operations cost and between 30% and 35% of total operations full-time equivalent.

“It is not uncommon to identify and unlock a 15 to 25 percent optimization potential in indirect functions, which can translate to a sizeable impact on the bottom line,” the report stated.

Optimizing indirect manufacturing functions can be achieved by benchmarking against peers and conducting an internal assessment between plants.

McKinsey said the benefits of benchmarking can be substantial. It said that over the past five years, it has analyzed around 1,000 plants to establish benchmarking practices that can help identify and quantify potential for improved performance.

The report noted how a chemical company found it could potentially improve the efficiency of its indirect functions by around 25% after leaders focused on optimizing processes and right-sizing functions within the organization.

A two-week top-down benchmarking exercise, backed by two weeks of shop floor observations and maturity assessments, provided insights into significant improvement opportunities.

After optimization, the company saw a 12% to 18% decrease in logistics costs, a 20% to 24% decrease in quality costs, and about a 30% decrease in maintenance costs—freeing up resources that the company could reinvest for increased plant performance.

A company should identify performance gaps and systematically examine and understand the factors behind them. McKinsey suggests seven ways to transform and improve indirect functions.

  • Reduce demand: Decreasing the number of work packages, reports, and meetings has a typical impact of 5% to 15%.
  • Consolidate and outsource: Adjusting the scope of responsibilities between local, central, and external roles has a typical impact of 5% to 10%.
  • Optimize process efficiency: Streamlining processes and tasks can see an impact of 5% to 15%.
  • Implement stringent performance management: Ensuring optimal delivery of core activities while monitoring efforts to continuously improve is essential for improvement over time.
  • Digitize: Introducing intelligent systems, such as robotic process automation to replace manual work, can achieve impact of 20% to 50%.
  • Optimize organizational structure. Removing overlaps, decreasing the number of layers, and adjusting spans of control can see a 5% to 10% impact.
  • Develop capabilities. Improving team members’ skill sets, particularly versatility and productivity, can see an impact of 5% to 20%.

Assessing and benchmarking processes in indirect functions are considered more complex than in direct areas, but payoff—pinpointing needed changes so that the company can focus its transformation for impact—is worth the investment, said McKinsey.

“Companies that realize the potential from improving indirect operations could develop a competitive edge and build up resilience to better face the instabilities of today’s market,” it said.

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