IKEA’s business and operating models: a match made in heaven

“For us, good design is the right combination of form, function, quality, sustainability and a low price. We call it ‘democratic design’, because we believe good home furnishing is for everyone. It’s why we’re constantly exploring smarter, thriftier ways to do things.” – IKEA Website

With revenue of over 29 billion euros in 2014, 315 stores in 27 countries, 9,500 product types, and 147,000 employees, IKEA Group is one of Sweden’s best-known companies. IKEA designs, manufactures, and supplies quality furniture at low prices to make it accessible to the majority of people. IKEA’s furniture products are designed to be sleek and minimalist, and manufactured to be easy to assemble and maintain.

IKEA is a great example of a company that effectively aligns it business model and operating model. In order to deliver on its customer promise of providing quality furniture at affordable prices, IKEA relies on its value chain to optimize its production and overhead costs, as exemplified below:

Product design process:
In order to reach the shop floor, a product must meet four criteria: affordability, sustainability, good design, and functionality. Interestingly, the design-planning of any product starts by first setting a price at which a product will be sold. As part of that, designers have to select which design elements, raw materials, and production techniques to use in order to reduce production costs. Furthermore, the designers often work on the factory floor, directly interacting with the manufacturing team in order to understand the capabilities and constraints of the manufacturing department, thereby streamlining the design process and minimizing the cost of the prototyping phase.

In addition to that, IKEA standardizes the production processes by using a limited selection of raw materials across the product ranges and it uses the same base design for different products (example: the chairs from the PELLO series have the same base design as chairs from the POÄNG chairs). This level of standardization results in lower rates of defect and scrap, therefore less waste and cost.

Production & Distribution:
IKEA has over 50,000 SKUs; in order to relieve the challenge of product variability, IKEA relies on extensive forecasting, and usually planning production five years in advance. Similar to Toyota’s Heijunka practice, IKEA relies on long-term planning to evenly balance production volumes across its network of more than 1,000 third-party manufacturers. As we learned in the TOM course, spreading out production demand allows for suppliers to have a uniform cycle time which ultimately leads to lower production costs per unit. Furthermore, with the help of an Advanced Planning and Scheduling software, IKEA allocates production to suppliers based on each supplier’s production capacity and raw material availabilities.

After productions, the products are transported to a network of 47 IKEA-owned, highly-automated distribution centers located in 17 countries. In order to optimize on warehousing and transportation requirements, the finished products are tightly packed into flat packages. This type of packages makes the finished goods easy to transport (leading to decreased transportation costs) and easy to store (leading to decreased warehousing costs).

Retail:
After customers browse the shop floor and select the items to purchase, they head to the store’s warehouse to retrieve the packages themselves. Because the customers are responsible for picking up their packages, IKEA does not have to hire labor that would otherwise assume such a responsibility. This helps drive down IKEA’s labor cost.

Consumers play another role in IKEA’s low-cost strategy. Because the customers are responsible for transporting the furniture out of the store and assembling it, IKEA further saves on labor, shipping and overhead costs associated with furniture assembly and delivery.

Overall, I think IKEA effectively manages several key elements of its value chain from design-process to its retail stores, and it has access to customer’s demand patterns. With this information flow and control from one end of the supply to the other, IKEA is able to smoothen the bullwhip effect that other firms typically experience. This in turn helps IKEA drive operational efficiencies throughout the supply chain, resulting in reduced costs and lead times. Given IKEA’s strong financial performance with profit margins of over 11%, I believe that that IKEA’s business and operating models are strongly aligned with one another.

 

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4 thoughts on “IKEA’s business and operating models: a match made in heaven

  1. IKEA has a unique value proposition that it delivers to its customers and it seems it has been able to be successful because of the distinct brand image it has developed together with reduced costs to effective supply chain management and scalability.

    I found it extremely interesting it the way IKEA develops products. It seems intuitive that the designers work together with the production team on the factory shop floor to develop products that are functional, aesthetic and yet provide good value for money. In most companies the design and production team are separate even though there are obvious synergies between the two.

    What I also found interesting is that, IKEA plans its production 5 years in advance. While this helps to smooth out demand forecasts, I was wondering what this would mean for changing trends in design? It seems that design trends change season to season, so how is IKEA able to keep up with design trends, if they plan 5 years in advance?

  2. This is a great post Amine! I think IKEA is a great example of a company creatively disrupting what used to be a standard – and clunky, and expensive – event in a person’s life. IKEA set out to democratize design. Their mission is to “create a better everyday life for the many people” and so much of that comes back to the elements you discussed (http://www.ikea.com/ms/en_SG/about_ikea/our_business_idea/index.html). I would like to add a couple of notes expanding on your product design process idea.

    First, IKEA does its research. When IKEA first came to the US, it dropped off truckloads of products all measured in centimeters and Americans rejected them. IKEA has learned, and now sends anthropologists into countries to learn how people interact with their homes and what their lives are like. They publish a quarterly “Life at Home” report with qualitative and data-intensive quantitative findings. For example, here is a sample showing differences in peoples’ habits in the kitchen around the world: http://lifeathome.ikea.com/food/en/. Based on this research, IKEA might develop products, but more often they learn how their existing products can fit into the lifestyles of people around the world. IKEA stores’ showrooms and catalogs tell people how to integrate products into their lives, and with this anthropological understanding, IKEA can adapt its products to fit the world and increase volumes, creating further economies of scale (http://fortune.com/ikea-world-domination/).

    Second, IKEA is conscious that when you supply the world with tables and chairs, you are also taking a lot from the world. IKEA uses an incredible 1% of the world’s wood supply, which is roughly 17.8 million yards of wood (http://gizmodo.com/heres-why-ikea-is-discontinuing-everyones-favorite-sh-1527126312). In 2012 IKEA published an intensive report detailing their sustainability strategy in which they begin by stating they would “economise with resources” (http://www.ikea.com/ms/en_US/pdf/reports-downloads/sustainability-strategy-people-and-planet-positive.pdf). Holding true to that mission, a little over a year later they replaced the beloved EXPEDIT bookcase (a bestseller), with the KALLAX; the only difference between the two was shaving down the width of the outside wooden pieces. It is a small change, but at the volumes this bookcase is sold it has a meaningful impact on IKEAs raw material usage. This demonstrates IKEAs iterative product development expertise, helps them lower costs, and more importantly supports their philosophy of creating a better life for many people – if they can reduce their wood usage, they can bring their product to more people without further environmental impact. Bring on the Poang.

  3. Dear Amine,

    Great note and highlight on Ikea’s operating & business models! That is very telling. My question was about subproduction. It seems IKEA outsources part of its manufacturing to Chinese and Indian manufacturers for cost logics. How do you think Ikea can keep an edge, as it is being copied by some of its Chinese sub contractors?

    Another question I have is about IKEA’s terrible customer service. Do you think that a wrong customer service may hamper Ikea’s s sales on the long run? Isn’t it part of the business model?

    Thanks again for you note, really interesting!

  4. Great post Amine. I really liked the way how you brought to life the operating model of IKEA – an innovative industry leader. IKEA is certainly a good example of a company which has effectively employed lean supply chain management practices. I had a few questions regarding this strategy.
    1. Can you elaborate on IKEA’s third party manufacturer suppliers? Are they based in Sweden or in low cost locations in developing countries? I am assuming that at this price point, they will need to be sourcing cheap.
    2. Since the design and production functions have to work together to ensure standardization, how is this managed with manufacturing being outsourced? Does IKEA have its design teams working with the third party manufacturers?
    3. What is IKEA’s raw material procurement strategy?
    4. I find it quite incredible that IKEA has a 5 year demand forecast. Given that it has 50,000 SKUs, does IKEA only forecast demand for the base models or for all 50,000 SKUs?

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