Harvard Business School Working Knowledg e Archive

Capability Sourcing at 7-Eleven

3/28/2005
7-Eleven was once the model of vertical integration—but that capability became less strategic in a global, connected environment. Here's how the company learned the advantages of "capability outsourcing." An excerpt from Harvard Business Review.

Editor's note: As the forces of globalization redefine the very nature of competition, it's becoming clear that ownership of capabilities isn't as important as control of capabilities. In the early 1990s, 7-Eleven was the model of the vertically integrated company—it even owned the cows used to produce its milk products. At the same time, however, 7-Eleven was losing money and market share. Enter new CEO Jim Keyes, who quickly realized his company needed to do fewer things better.

Welcome to the age of "capability sourcing"—companies are focusing on the things they do best and outsourcing all other functions to trusted partners. This excerpt from the Harvard Business Review article "Strategic Sourcing: From Periphery to the Core" discusses 7-Eleven's capability sourcing evolution.

To illustrate the power of capability sourcing, let's take a detailed look at one dramatically successful practitioner, which began as a most traditional, vertically integrated company.

Back in 1991, when 7-Eleven's current CEO Jim Keyes was named vice president of planning and chairman of the executive committee, the retailer was losing both money and market share. As the major oil companies added mini-marts to more and more of their gas stations, the convenience store industry was becoming crowded and cutthroat, putting both revenue and margins under intense pressure. To attract more customers, 7-Eleven needed to cut its operating costs substantially, expand the range of its products and services, and increase the freshness of food items.

Keyes launched a business review aimed at tightening operations, rebuilding competitive advantage, and perhaps divesting a few noncore businesses. The deeper he and his team got, however, the more apparent it became that 7-Eleven was trying to do too many things and was not good enough at any of them. The core of the business, Keyes believed, was merchandising skill—the pricing, positioning, and promotion of gasoline, ready-to-eat food, and sundries for consumers driving cars. But 7-Eleven had always been vertically integrated, controlling most of the activities in its value chain. The company operated its own distribution network, delivered its own gasoline, made its own candy and ice. It even owned the cows that produced the milk it sold. Managers were required to do lots of things other than merchandising—store maintenance, credit card processing, payroll, and IT systems management. Keyes found it hard to believe that the company could be best-in-class in every one of those functions.

As part of his initial assessment, Keyes studied the company's highly successful Japanese unit, whose keiretsu model of tight partnerships with suppliers was unique within 7-Eleven. By relying on an extensive and carefully managed web of suppliers to carry out many day-to-day functions, the Japanese stores were able to reduce their costs and enhance the quality of their operations, spurring rapid growth and strong profits. After considering many options, Keyes concluded that the best way to save the U.S. company was to adopt the Japanese model. The goal he set was to "outsource everything not mission critical." This marked an abrupt and deliberate break with the company's vertically integrated past.

If a partner could provide a capability more effectively than 7-Eleven could itself, then that capability became a candidate for outsourcing.

All activities were on the table. Keyes's team even evaluated strategic functions such as product distribution, advertising, and procurement, attempting to identify outside partners with greater expertise and scale. Simply put, if a partner could provide a capability more effectively than 7-Eleven could itself, then that capability became a candidate for outsourcing. Over time, the company relinquished direct ownership of many parts of its business, including HR, finance, IT management, logistics, distribution, product development, and packaging. Yet despite moving at a rapid pace, Keyes remained cautious about losing control and avoided the temptation to take a one-size-fits-all approach to outsourcing.

Picking the right providers
The way 7-Eleven has structured each partnership depends on how important each function is to the company's competitive distinctiveness. For routine capabilities like benefits administration and accounts payable, 7-Eleven picks providers that can consistently fulfill cost and quality requirements. More strategic capabilities require more complex arrangements. Gasoline retailing, for example, represents an important source of revenue for many 7-Elevens, as gas is often the reason customers come to the stores. So while the firm outsources gasoline distribution to Citgo, it maintains proprietary control over gas pricing and promotion—activities that could differentiate its stores if done well.

The company has paid similarly close attention to its relationship with Frito-Lay, since snack foods are one of the most important product lines for convenience stores. By allowing Frito-Lay to distribute its products directly to the stores, 7-Eleven has been able to take advantage of the chip maker's vast warehousing and transport system. But unlike other convenience store companies, 7-Eleven doesn't allow Frito-Lay to make critical decisions about order quantities or shelf placement. Instead, the retailer mines its extensive data on local customer purchasing patterns to make those decisions on a store-by-store basis.

The choice 7-Eleven has made to maintain control over product selection and stocking illustrates a critical issue in strategic sourcing partnerships: when to keep vital data confidential and when to share them with a partner. Similarly key was 7-Eleven's decision to rely on an outside vendor, IRI, to maintain and format detailed customer purchasing behavior data while keeping the data themselves proprietary. This gives 7-Eleven a picture of the mix of products its customers want in different locations without relying on outside decision makers like Frito-Lay for such information. In this way, 7-Eleven is able to structure its supplier relationships to gain a capability without relinquishing control over decisions that could make or break its business.

For a few targeted product segments, 7-Eleven has identified opportunities that call for an even deeper level of collaboration. Company executives figured out that their traditional, do-it-yourself approach to creating branded products was cutting the company off from the superior scale, resources, and creativity of major food suppliers. So they began sharing information with a select group of manufacturers, allowing them to create custom products for 7-Eleven stores. For example, 7-Eleven worked with Hershey to develop an edible straw based on the candy maker's popular Twizzler treat. In return, Hershey gave 7-Eleven the exclusive right to sell the straw for its first 90 days on the market. To further promote the unique product, 7-Eleven joined with its syrup supplier, Coca-Cola, to come up with a Twizzler-flavored version of its proprietary Slurpee drink. Such exclusive arrangements reduce the strategic risk of sharing customer information while greatly expanding the set of unique products 7-Eleven can offer.

Likewise, when the data on beer sales showed that certain packaging options were more successful than others, 7-Eleven forged a tight partnership with Anheuser-Busch to build sales in those categories. Anheuser-Busch helped 7-Eleven develop a product assortment and establish merchandising standards for a new display. The beer giant also agreed to give 7-Eleven first-look opportunities at new products. In return, 7-Eleven shares its customer information so together the two companies can develop innovative marketing programs, such as a co-branded NASCAR promotion targeting 7-Eleven's core customers and a Major League Baseball promotion campaign. Anheuser-Busch is also using 7-Eleven store data, provided daily by IRI, to test a new order-forecasting system that would link the retailer's orders more tightly with deliveries from the brewer's wholesalers.

Leveraging the one-stop shop
In addition to restructuring and enhancing existing activities, 7-Eleven has used creative sourcing partnerships to pioneer entirely new capabilities. It realized, for example, that by being a one-stop source for a broad range of products and services, it could gain a leg up on more narrowly focused competitors. So it has set up a consortium to provide multipurpose kiosks in its stores. American Express supplies ATM functions, Western Union handles money wires, and CashWorks furnishes check-cashing capabilities, while EDS integrates the technical functions of the kiosks. Here, too, 7-Eleven maintains control over the data—in this case, information on how customers use the kiosks—which it views as critical to its competitive edge.

The choice 7-Eleven has made to maintain control over product selection and stocking illustrates a critical issue in strategic sourcing partnerships.

Some of 7-Eleven's outsourcing relationships tie suppliers' financial interests to its own. The company took an equity stake in Affiliated Computer Services, for instance, one of its major IT outsourcers. 7-Eleven also agreed to share productivity gains from a services agreement with Hewlett-Packard. In an even deeper collaboration, the company created a joint venture with prepared-foods distributor E.A. Sween: Combined Distribution Centers (CDC) is a direct-store delivery operation that supplies 7-Elevens with sandwiches and other fresh goods. By drawing on the skills and scale of a specialist, 7-Eleven was able to cut its distribution costs from more than 15 percent of revenues to 10 percent and eventually hopes to cut that figure in half again. But cost reduction is only a secondary benefit. The real gains have come in service. When it owned its own distribution network, 7-Eleven delivered fresh goods to its stores only a couple of times a week. CDC now makes deliveries to stores once, and soon twice, a day. More frequent deliveries mean fresher products, which draw more customers into the stores.

By almost any measure, 7-Eleven's sourcing strategy has transformed the company. In narrowing its focus to a small, strategically vital set of capabilities—in-store merchandising, pricing, ordering, and customer data analysis—the company has reduced its capital assets and overhead while streamlining its organization. It reduced head count 28 percent from 43,000 in 1991 to 31,000 in 2003 and flattened its organizational structure, cutting managerial levels in half from 12 to six.

Today, 7-Eleven consistently outperforms competitors. Same-store sales have grown in four out of the last five years. In the past two years, it has dominated the industry's vital statistics, with same-store merchandise growth at almost twice the industry average, revenue per employee at just about two-and-a-half times higher, and inventory turns at 72 percent more than the industry average. Furthermore, after its acquisition of two regional U.S. chains (Christy's Markets in the Northeast and Red D Mart in the Midwest), the firm's new business model helped grow sales by more than 30 percent and increase gross profit margins by 2 percent. 7-Eleven's stock appreciation over the past five years has outpaced all major competitors, including Casey's General Stores, the Pantry, and Uni-Mart.

Excerpted with permission from "Strategic Sourcing: From Periphery to the Core," Harvard Business Review, Vol. 83, No. 2, February 2005.

Mark Gottfredson (mark.gottfredson@bain.com) in Dallas, Rudy Puryear (rudy.puryear@bain.com) in Chicago, and Stephen Phillips (stephen.phillips@bain.com) in London are partners in Bain & Company.

How 7-Eleven Measures Success

by Mark Gottfredson, Rudy Puryear, and Stephen Phillips

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Used with permission from "Strategic Sourcing: From Periphery to the Core," Harvard Business Review, Vol. 83, No. 2, February 2005.