Rewiring Europe: Turning pressure into performance

Christian Johnson: 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 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. Europe stands at a productivity crossroads. Without decisive action, the the continent risks falling behind for decades. But there is a clear path forward. 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 Heuis is the co leader of the firm's operations practice globally and a senior partner in McKinsey's Berlin office. She serves clients on future mobility, decarbonization strategies and product development for automotive 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.

Dr. Jan Mischka: Yeah, 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. Uh, essentially the energy shock following the war in Ukraine. It is the technology shock, uh, 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, uh, way forward for Europe to regain competitiveness but also maintain uh, or regain strategic autonomy in the world.

Christian Johnson: And Ruth, could you tell us how some of these pressures are playing out in your clients in Europe right now?

Dr. Ruth Heuis: So as Jan said, there's um, multiple forces at work. Uh, and if you turn to the operations arena, I think, um, two, three things which are really obvious. Number one, if you look at global supply chains, they're um, massively under distress because of the geopolitical space, um, 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, uh, if something happens that you can go much faster from solution A to solution B. I think another thing where it is absolutely obvious is um, the product development process, uh, in many of the areas where we have like had our historical strengths like in automotive machinery. And we do see that mainly the Chinese, but to a certain extent also the US based players, um, they start from ah, a clean sheet of paper regarding the processes and they got much, much faster, uh, because we are following a lot of rules, regulations, safety procedures which are obviously also there because uh, 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

Christian Johnson: again developing a uh, faster metabolism if you will.

Dr. Ruth Heuis: And maybe the third thing I would like to highlight. Um, so we have in Europe always thought about uh, manufacturing in a way that we are super productive because we have automation tools, machinery that enables us to uh, produce with less hours, um, of real people, uh, 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're doing at the Global Lighthouse, uh, network, which is a network of plants which are really um, the best plants on the planet, um, this research tells us that there's a lot of those lighthouses now in Asia and not only in China, but more broadly Asia, um, where we tend to believe that there's a lot of low cost labor, um, and people are relying on that labor for the production process. Uh, but the contrary is true. So they are all um, uh, leveraging digital tools, Genai robots, autonomous vehicles already in their production sites, uh, and I would say to a much higher extent than we do that in Europe.

Christian Johnson: 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?

Dr. Ruth Heuis: So if I look at the companies that I'm actually working with, um, many of those are in the automotive industry. Um, they're scratching their head around uh, speed and uh, also cost positions. So the Chinese competition, but also Tesla, uh, is um, much faster in their go to market. Ah. And in particular the Chinese, they are really useless in um, cost, uh, takeout. Ah, so they do a 5 to 10% cost reduction every year. That's something we used to do over five to seven years. Ah. 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 um, it really, really is a difficult position for us.

Christian Johnson: So China is no longer just the low cost option and that raises the competitive pressure. Right.

Dr. Ruth Heuis: We are still, uh, I think in the European market benefiting from brand perception, from also obviously consumers who are very slowly only changing brands because of um, their fear, um, before, like um, quality issues, but also safety issues. But if you look 10 years ahead and the Chinese products don't um, experience any of that, ah, so no major recalls, no problems, uh, in safety. I think we will also see, especially in current times where consumers just are not willing to spend as much, um, we will see much more adoption.

Christian Johnson: Sujan, I wonder if you could tell us about some of the constraints that European companies are currently facing and how those are affecting productivity.

Dr. Jan Mischka: Yeah, a lot has been said and written, uh, about all the bottlenecks and issues that are serving as strong headwinds to European firms and pursuit of innovation and uh, productivity. I would say the ones that are coming out front and center, uh, usually have to do with scale or the issue of fragmentation across European markets. Um, there's some research suggesting the um, 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 uh, quite extreme. And that matters particularly in advanced industries where you want to scale your innovation, your intangibles, your software, your R and D across as many customers as you can.

Christian Johnson: Right. And AI could provide a way to overcome these barriers to scale. Um, Ruth, how do your European clients today think about AI?

Dr. Ruth Heuis: So our research shows that um, 80% of the companies are experimenting with AI, generative agents and the likes. But only 20% of the companies currently say that they do see material, um, improvements in their uh, operations. The ones who are experimenting typically take two different routes. Ah, one route is a very structured strategic approach that goes basically through all. The whole company prioritizes, use cases, um, sets up like an infrastructure backbone and people then go after uh, the changes based on the priorities. The second thing we see is a very much um, end to end process or functional view on things where uh, particular processes or functions are being prioritized. So for example, the end to end supply chain. And I say end to end because it starts with customer understanding and it uh, ends with customer delivery.

Christian Johnson: Ah, what sorts of impact do companies see by taking this end to end view?

Dr. Ruth Heuis: 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, uh, that they are actually being delivered by. Ah, so there's a lot of, uh, additional improvements that, uh, somebody can yield, um, by really rewiring 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.

Christian Johnson: Sujan, 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?

Dr. Jan Mischka: If you actually look at our research at productivity from the firm level up, uh, it is actually remarkably few firms that can move the needle and really make a difference. So while of course waiting and hoping for the best on the regulatory and reform side, each executive now would be best placed to move ahead, uh, 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, a similarly sized, uh, sample that's been 42 firms. It's 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 they are a combination of also including all Ruth says earlier around the effects of supply chain, um, improvements, for instance, are usually also a lot about improving customer value, changing business and operating models, or just working, uh, at a different level of scale or in a different product portfolio.

Christian Johnson: So for companies that are currently behind, feeling the pressure, what's the from to of the most important things for them to change internally? To be able to meet this challenge,

Dr. Ruth Heuis: I think first of all there needs to be an impulse, um, from the leadership team that we are going to grasp these, um, technologies because there is always also in particular in Europe, I think, uh, fear, uh, that this will come only with job losses. Um, while in reality we also see you're leveraging Genai 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 um, to survive and uh, strive in the markets. I uh, think the second piece is to do that in a very cautious uh, way so that you really benefit from um, the first examples and why do I say that? So it's very easy to leverage ChatGPT for email writing, um, but at the end of the day basically you're working still as long, maybe you've got five more emails written uh, or read. Um, it's very important for every company to figure out where can you really improve productivity and where is it. Just like the ah, 3 to 5% of additional performance improvement that you see on a yearly basis uh, in order to really make the first few instances success cases that help the company but potentially also help the people to um, uh better actually accept and learn uh, how to leverage the technology going forward.

Christian Johnson: Jan, you alluded earlier to how just a few companies are driving many major productivity improvements. The leaders now separating from the laggards. What do these productivity leaders do differently?

Dr. Jan Mischka: Yeah, I would 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 are say um, a full assortment retailer to improve your operations and become much more efficient, uh, you have to do that um, ah and companies are doing it all the time and some that do it also are 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 uh, e commerce platform together with an also digital uh, fulfillment platform that is essentially inherently more productive as a business model and that is essentially what drives much of the differences. That kind of uh, also brings me to a related point that what we see in terms of the companies becoming standout firms that really drive uh productivity in each sector they usually do their very own idiosyncratic choices. It's not that in retail not 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 is much more interesting is how do you get the operations in your business model uh to become much more efficient and productive and how do you boost the customer value in your specific business model and value proposition which might be much more around going to convenience formats, going uh, to luxury brand. There's kind of all kinds of different place. There's no one size fits all. Answer.

Christian Johnson: Ruth, you mentioned the Global Lighthouse Network or GLN earlier. Could you tell us more about the GLN significance for manufacturing, particularly in Europe?

Dr. Ruth Heuis: So this is a network of um, by now more than 200 plants, uh, which exists uh, since 10 years. Uh, we are collaborating there with um, World Economic Forum to uh, every year single out a few plants who are the most advanced, um, in manufacturing and supply chain.

Christian Johnson: So Ruth, I wonder, perhaps based on your work with the Global Lighthouse Network, these very advanced production facilities and uh, 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?

Dr. Ruth Heuis: So what we have observed in the last two, three, four years, um, Genai use cases have actually come from, uh, test cases, proof of concepts to like a widespread use, uh, in the most advanced, uh, companies. And the second thing that we're currently noticing is that um, the use of robots, uh, um, is also uh, following the same pattern. It's mostly at the moment automatically autonomous vehicles in the plant for um, actually delivering supplies. Uh, but we do see already a lot of um, POCs on also humanoids, uh, somehow helping in the manufacturing sites. This is like the top of the iceberg, the best of the best of the best factories. Uh, 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. Um, um, most of those lighthouses, um, are in Asia by now. And um, that's something that I did not expect when we started that work. Ah, that this would actually be the case. Um, I think we need to be a bit more innovative, we need to trust a bit more in technology in Europe, uh, in order to lead um, the productivity game and not be the last one, um, who is actually jumping on the train. Because we cannot afford that, given both our age structure but also uh, our income structures.

Christian Johnson: Jan, 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.

Dr. Jan Mischka: I might maybe just add that also for European firms to get back to the front, uh, there's probably a few avenues to uh, keep in mind, one thing is actually look at where the leading technology, the leading practices, the uh, most innovative firms are and these today are often in Asia and China. Learn from them, work from them, get them onshore into Europe, essentially the same way that China did it with European firms 20 and 10 years ago, uh, 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. And in artificial intelligence that might include also using it in areas where others are not that strong yet. To give you an example, healthcare, uh, in Europe is a strong area. Uh, we have strong midtech firms, we have pharma companies using AI for accelerating research and innovation of new drugs and development. So this could be a vertical area where Europe could actually shift it itself to the front, uh, and to the frontier.

Christian Johnson: Could you give us a concrete example of how agentic AI is already being used?

Dr. Ruth Heuis: I think the most impressive use case that I have seen most recently is a, uh, use case where an agent, or basically a squad of agents did rewrite software code. And um, that was um, in a context where there was old software, where there was basically almost nobody still understanding how to write that code. Uh, just a few people also, almost all, uh, at the verge of retirement who could still, um, program that language, where a team of ours with the clients, um, have basically created a squad of agents. Ah, 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, um, uh, that um, the company could then actually work with, with the supervision of five to ten real humans. And that would have historically been outsourced to um, ah, a service provider company, um, that would have actually worked with 100 people instead of 100 agen, um, over a few months, ah, to uh, do exactly the same things.

Christian Johnson: So stepping back and thinking very broadly, how optimistic do you feel right now about European businesses making these shifts?

Dr. Jan Mischka: 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, uh, I think they're also becoming more outspoken and the changes needed in the investment environment, uh, regulatory environment around them. So that will actually hopefully also give them some tailwind in terms of their um, reform agenda coming to fruition.

Christian Johnson: Ruth, what do you think?

Dr. Ruth Heuis: 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 uh ah and that's the first step um 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 um that's why I'm optimistic uh but also not yet positive on what has been achieved but optimistic on we now are actually getting onto the journey.

Christian Johnson: 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 um 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 Talks operations with me, Christian Johnson. If you like what you've heard, subscribe and stay tuned. Another great episode starts now.