Rewiring Europe: Turning pressure into performance

[Music] Your company's future success demands customer-focused agile, resilient and efficient operations. I'm your host, Christian Johnson, and you're listening to McKinsey Talk's Operations, a podcast where the world seesweet leaders and McKinsey experts cut through the noise and uncover how to create a new operational reality. Europe stands at a productivity crossroads, without decisive action, the continent risks falling behind for decades. But there is a clear path for. As we'll hear from our guests today, this productivity transformation is not just about efficiency. It's essential for meeting sustainability goals, staying competitive in rapidly changing markets and securing Europe's long-term prosperity. I'd like to introduce our guest for this episode. Dr. Jan Mischka is a partner at the McKinsey Global Institute, or MGI, McKinsey's Business and Economics Research Arm, based in Zurich. Since 2010, Jan has led MGI's research on productivity and prosperity. Dr. Ruth Hoyes is the co-leader of the firm's Operations Practice Global, and a senior partner in McKinsey's Berlin office. She serves clients on future mobility, decarbonization strategies, and product development for audit mode of OEMs and suppliers. So I'd like to start with a very basic question, which is, why is the topic of rewiring so important in Europe right now, and Jan, perhaps, to go to you first to provide a little bit of context here? I think in the end, it's about productivity, and productivity is really what drives long-run prosperity. But while it's always important, at this point, it's actually also unusually urgent. Europe is essentially hit by multiple shocks simultaneously. Essentially, the energy's shock following the war on Ukraine. It is the technology shock coming mostly from the US. It is the competition shock coming mostly from China. And then there's the slow-moving demographic and aging shock if you combine all those four. Then essentially, productivity is the only way forward, and it is an urgent way forward for Europe to regain competitiveness, but also maintain or regain strategic autonomy in the world. And Ruth, could you tell us how some of these pressures are playing out in your clients in Europe right now? So as Jan said, there's multiple forces at work. And if you turn to the operations of Rina, I think the two or three things which are really obvious. Number one, if you look at global supply chains, they're massively under distress because of the geopolitical space, the tariffs, all those regulations. So regaining to a certain extent, at least the visibility on where parts actually come from and how you can react is a very important topic. And obviously also the agility that's required if something happens that you can go much faster from solution A to solution B. I think another thing where it's absolutely obvious is the product development process in many of the areas where we have like had our historical strengths like in automotive machinery. And we do see that mainly that Chinese, but to a certain extent also the US-based players, they start from a clean sheet of paper regarding the processes and they got much, much faster because we are following a lot of rules, regulations, safety procedures, which are obviously also there because over the last decades there were a lot of incidents, but we somehow missed to actually look into the process and see what really matters and what not and how we can be much faster again. Developing a faster metabolism if you will. And maybe the third thing I would like to highlight, so we have in Europe always a thought about manufacturing in a way that we are super productive because we have automation towards machinery that enables us to produce with less hours of real people by really leveraging technology around us. The reality in the last, I would say almost one decade, if we look into our research that we are doing at the Global Lighthouse Network, which is a network of plants which are really the best plants in the planet. This research tells us that there's a lot of those lighthouses now in Asia, not only in China but also more broadly Asia, where we tend to believe that there's a lot of low-cost labor and people are relying on that labor for the production process, but the contrary is true. So they are all leveraging digital towards Genie, Eye, Robots, Autonomous Vehicles already in their production sites. And I would say to a much higher extent than we do that in Europe. So if I can follow up on that, how are these forces playing out at the company level? So what do you hear from senior executives about how they're experiencing these forces? So if I look at the companies that I'm actually working with, many of those are in the automotive industry. They're scratching their head around speed and also cost positions. So the Chinese competition but also Tesla is much faster in their go-to market. And in particular, the Chinese are really useless in costs take out. So they do a 5% to 10% cost reduction every year. That's something we used to do over 5 to 7 years. And if you look at that, for example, Chinese players are now coming over to Europe and having very, very competitive products, not only in terms of cost but also in terms of technology. So that's really, really is a difficult position for us. So China is no longer just the low cost option and that raises the competitive pressure, right? We're still, I think, in the European market benefiting from brand perception, from also obviously consumers who are very slowly only changing brands because of their fear before quality issues but also safety issues. But if you look 10 years ahead and the Chinese products don't experience any of that, so no major records, no problems in safety, I think we will also see, especially in current times who are consumers, just are not willing to spend as much. We will see much more adoption. So, Yann, I wonder if you could tell us about some of the constraints that European companies are currently facing and how booze are affecting productivity. Yeah, a lot of has been said and written about all the bottlenecks and issues that are serving as strong headwinds to European firms and the pursuit of innovation and productivity. I would say the ones that are coming out front and center usually have to do with scale or the issue of fragmentation across European markets. There are some research suggesting the barriers to trade across European countries are actually sometimes higher than the barriers to trade with the US for each individual country, which would be quite extreme. And that matters particularly in advanced industries where you want to scale your innovation, your intangibles, your software, your R&D across as many customers as you can. Right, an AI could provide a way to overcome these barriers to scale. Ruth, how do your European clients today think about AI? So, our research shows that 80% of the companies are experimenting with AI, Gen AI, agents and the likes, but only 20% of the companies currently say that they do see material improvements in their operations. The ones who are experimenting typically take two different routes. One route is a very structured strategic approach that goes basically through all the whole company, prioritized use cases, sets up like an infrastructure backbone. And people then go after the changes based on the priorities. The second thing we see is a very much end to end process or functional view on things. There were particular processes of functions are being prioritized. So for example, the end to end supply chain, and I say end to end because it starts with this customer understanding and it ends with customer delivery. What are the impact of companies see by taking this end to end view? The interesting piece is that we not only see cost improvements, but for example for this end to end supply chain improvement, we also see net promoter scores going up because the customers are actually more happy with the quality of the delivery, with the option choices, with the time that they are actually being delivered by. So there's a lot of additional improvements that somebody can yield by really reviring their functions. But as said, I think we just see the start of the journey not only because the companies are only starting, but also because the technology is progressing so quickly. So, Jion, how do you see this at a European scale? If you're looking at research across the continent, what are some of the big changes that you think need to happen for companies to start making these sorts of transformations? If you actually look at our research at productivity from the firm level up, it is actually remarkably few firms that can move the needle and really make a difference. So why are you of course waiting and hoping for the best on the regulatory and reform side? Each executive now would be best placed to move ahead in any way they can right now to give you some striking statistics. When we looked at samples covering about 15% of the German economy, it was 13 firms that delivered two thirds of the productivity contributions. And even in the much larger US market, similarly sized sample, that's been 42 firms. Essentially each and every CEO and of course the teams around them can become such standouts that you can see in the national statistics and that can really move the needle for the entire country or even for their entire continent in a meaningful way. What it takes for them when we look at what these companies do is big bold moves and these big bold moves can essentially of course be on the on the cost and efficiency side, but quite often there are a combination of also including all with us earlier around the effects of supply chain improvements for instance. I usually also a lot about improving customer value, changing business and operating models or just working at a different level of scale or a different product portfolio. So for companies that are currently behind feeling the pressure, what's the from two of the most important things for them to change internally to be able to meet this challenge? I think first of all there needs to be an impulse from the leadership team that we are going to grasp these technologies because there is always also in particular Europe I think fear that this will come only with job losses. While in reality we also see your leveraging Jenny I just the demand increases for example in call centers because you had call centers who were not very performant so people wouldn't call because they know that nobody would help them. So all of a sudden when you actually improve the quality in the call center you just get much more inbound calls. So it's very important that you actually start from the top and also explain how that can help us to survive and strive in the markets. I think the second piece is to do that in a very cautious way so that you really benefit from the first examples. And why do I say that? So it's very easy to leverage chat GPT for email writing app but at the end of the day basically you're working still as long maybe you've got five more emails written or read. It's very important for every company to figure out where can you really improve productivity and where is it just like the 3 to 5% of additional performance improvement that you see on a yearly basis in order to really make the first few instances success cases that help the company but potentially also help the people to better actually accept and learn how to leverage the technology going forward. Jan you alluded earlier to how just a few companies are driving major productivity improvements. The leaders now separating from the laggard what do these productivity leaders do differently. Yeah, but in that case start off with the leading firms quite often first and foremost doing something very different. So it's one way of course if you say a full assortment retailer to improve your operations and become much more efficient. You have to do that and companies are doing it all the time and some that do it also I actually visible in the national statistics for driving productivity and the country forward. But it's of course an entirely different thing if you do that entirely on an online e-commerce platform together with a also digital fulfillment platform that is essentially inherently more productive as a business model and that is essentially what drives much of the differences. It kind of also brings me to a related point that what we see in terms of the companies becoming stand out firms that really drive productivity in each sector they usually do their very own idiosyncratic choices. It's not that in retail now everyone becomes super productive by adding an online channel they all have to but if you're a full assortment retailer it might just add a little bit of extra cost for not that much additional sales. What's much more interesting is how do you get the operations in your business model to become much more efficient and productive and how do you boost the customer value in your specific business model and and value proposition which might be much more around going to convenience formats going to luxury brand. There's kind of all kinds of different place there's no one size fits all answer. Ruth you mentioned the global lighthouse network or GLN earlier could you tell us more about the GLN significance for manufacturing particularly in Europe. So this is a network of by now more than 200 plants which exists since 10 years we are collaborating there was a world economic forum to every year single out a few plants who are the most advanced in manufacturing and supply chain. So Ruth I wonder perhaps based on your work with the global lighthouse network you know these very advanced production facilities and the companies that have created them. What are some of the factors that you have seen in those examples or elsewhere of what leaders are doing to create a real strategic distance between themselves and the followers. So what we have observed in the last two three four years gen AI use cases have actually come from test cases proof of concepts to like a widespread use in the most advanced companies. And the second thing that we're currently noticing is that use of robots is also following a same pattern. It's mostly at the moment autonomous vehicles in the plant for actually delivering supplies. But we do see already a lot of POCs on on also humanoids somehow helping in the manufacturing sites. This is like the top of the iceberg the best of the best of the best factories. But I do expect that in five to 10 years that will be the standard. And the thing that's troubling me is most of those lighthouses are not in Europe. Most of those lighthouses are in Asia by now. And that's something that I did not expect when we started that work that this would actually be the case. And so I think we need to be a bit more innovative. We need to trust a bit more in technology in Europe in order to lead the productivity game and not be the last one who's actually jumping on the train because we cannot afford that given our both our age structure but also like our income structure. Young, would you like to add to that because particularly when Ruth speaks about the age structure, some of the demographic challenges, I think that overlaps with some of your research correct? I might maybe just add that also for European firms to get back to the front. There's probably a few avenues to keep in mind. One thing is actually look at where the leading technology, the leading practices, the most innovative firms are and these two days today are often then in Asia and China. Learn from them, work from them, get them on shore into Europe. Essentially the same way that China did it with European firms 20 and 10 years ago when they learned. The other thing is also that playing eternal catch up will not be enough. In the end, if you want leadership, you also need to find ways to leapfrog and move back to the frontier in new areas and in new ways. In artificial intelligence, that might include also using it in areas where others are not that strong yet to give you an example of healthcare in Europe. We have strong mid-tech firms, we have farmer companies using AI for accelerating research and innovation of new drugs and development. This could be a vertical area where Europe could actually shift itself to the front and to the frontier. Could you give us a concrete example of how a gender AI is already being used? I think the most impressive use case that I have seen most recently is a use case where an agent or basically a squad of agents did rewrite software code. In a context where there was old software, where there was basically almost nobody still understanding how to write that code. just a few, a few people. people also almost all at the verge of retirement who could still program that language, where a team of ours with a client have basically created a squad of agents. So there were like 100 agents roughly, they were organized in teams, as you would have people organized in teams. The first thing they did was describe the code. So basically understanding the old code and saying what does every piece of that code actually do and then transfer it to a more modern code that the company could then actually work with with the supervision of five to ten real humans. And that would have historically been outsourced to a service provider company that would have actually worked with a hundred people instead of a hundred agents over a few months to do exactly the same things. So stepping back and thinking very broadly, how optimistic do you feel right now about European businesses making these shifts? It's maybe too early to be positive, but it is a good time to be optimistic in the end. Firms usually change when they have to and they have to now. I think they're also becoming more outspoken and the changes needed in the investment environment, regulator environment around them. So that will actually hopefully also give them some tailwind in terms of their reformage and are coming to fruition. Ruth, what do you think? I think the one thing which is actually really good is that at least the leaders that I'm talking to, they have understood the problem. And that's the first step towards change. And I think the problem has been understood for sure in companies. And I do hope that we really now also see some action going forward. And that's why I'm optimistic, but also not yet positive on what has been achieved. But optimistic on we now are actually getting onto the journey. So to sum up, European's productivity inflection point is a chance for CEOs to lead their companies in rewiring their operations. By combining technology, people and a multi horizon agenda, leaders can capture 20% to 40% productivity gains. That funds innovation and can secure long-term competitiveness. But the first critical question to answer is, are we scaling tech fast enough or are we waiting for proof that others are moving first? You've been listening to McKinsey Talk's operations with me, Christian Johnson. If you like what you've heard, subscribe and stay tuned. Another great episode starts now.