Chapter 6

Value Chain Analysis

The basic idea of value chain is quite simple, and is based on the chain of events that every product must go through from its inception to its eventual sale. Firstly someone has to invent it, and develop a process that will allow it to be produced. Then the raw materials & parts needs to be brought together to make it, after which it must be distributed to customers & eventually to the end users. At some point, customers must be persuaded to buy the product. Finally, once it is delivered, the firm needs to take care of any problems that arise, and sometimes offer spare parts and maintenance or other forms of after sales service. Value chain analysis is a way of seeing where in this chain or network of activities an organization is successfully adding value. It lets us pinpoint the particular capabilities & resources that are important to an organization and show precisely where and how they have been applied.

Strategic Decisions in the Value Chain

Deployment of Resources Vertical Integration

Which assets & capabilities an organization chooses to use in connection with specific activities. Whether the organization decides to carry out an activity itself, or to outsource it to a specialist supplier or a franchisee. Whether an organization tries to gain economies of scale, or other types of advantage, from the scale of its operations in a particular activity. Whether an organization tries to share one or more activities across different products & markets In which country of region an organization chooses to locate particular activities Whether the organization tries to gain advantage by linking its activities together in a new & different way.

Scale of Operations

Scope of Operations Location of Operations Linkages

Deployment of Resources
If an activity utilizes distinctive assets or capabilities then it may enable the organization to be differentiated from its competitors in the levels of quality it provides customers, or the benefits that it incorporates into its products. Capabilities can be deployed in production or in after sales service. Strong brands & reputations can be deployed to attract good staff, to give differentiation in marketing and sales, or to target a different market.

Vertical Integration & Outsourcing

A key issue in a value chain is how much of the organizations activities should be carried out in-house & how much undertaken by a partner. There are three ways in which firm can obtain the products or services. 1. It can buy them from third party suppliers on the open market. This is sometimes known as outsourcing, and can be a short term or long term commitment. A more recent term is insourcing where a firm is contracted to carry out a role but undertakes it within the organization rather than on its own premises. Suppliers may be located far away, usually in a foreign country, in which case the terms are offshoring or nearshoring. 2. It can produce them within its hierarchy, so that the people providing the product or service are under direct management control and have to do what they are told. 3. It can use other hybrid forms of organization that are intermediate between markets and hierarchies such as networks, joint ventures, strategic alliances & franchising arrangements. In these cases although the supplier is not under the direct control of its clients, there is a continuing relationship between them that is likely to make each more sensitive to the needs of the other. These types of structures allow the partners to develop specialist component parts jointly, or reach agreements about just-in-time deliveries.

Whatever form of outsourcing network an organization may consider joining, it has to arrive at a trade-off between five factors... Production & setup costs Transaction costs Flexibility & incentive Quality Control & the risk of loss of key resources

Production & setup costs: By using an outside supplier, an organization can take advantage of that firms economies of scale & its learning. This is particularly true when the potential suppliers have core capabilities that a firm would have difficulty in matching. Also sourcing from experiences third party supplier proves to be cheaper than usual. Transaction costs: There are three ways in which a supplier may try to exploit the situation for extra profit. a) A supplier may increase the amount in charges of its services, because it believes that the client has become dependent upon it, a practice sometimes known as hold-up. b) The supplier may promise more than it can deliver. This means that the supplier may claim certain things but does not have that guarantee of service to be provided. New suppliers usually try & learn on job during their projects. This is called adverse selection because it leads firms to select the wrong supplier.

c) The supplier might cut corners when it comes to delivering the product or

service, a danger known as moral hazard. It may use inferior quality components, skimp on quality assurance procedures, or use people with lower qualifications than those that it promised.

Flexibility & Incentives Not all suppliers are crooks & the profit motive does not necessarily make them try to exploit their clients. It also gives them an incentive to do things that the customer probably welcomes, such as keeping down production & deliver costs and inventory levels low.

The control of Key resources There are other grounds apart from quality, why a firm may decide that an activity is too strategically important to allow a supplier to take it over. It may fear that the supplier may exploit control of an important resource, or it may want its knowledge of the activity to remain proprietary.

# Other Parameters under outsourcing

Quality: Consideration of Quality may influence a firm either away from or towards outsourcing activities. A dedicated supplier may have capabilities superior to those a firm could develop on its own. In a young industry, a firm may be unable to locate a supplier or distributor with right expertise. It may also decide that an activity is so important to its overall costs or differentiation advantage that it has to control the quality directly, and if necessary, learn how to do it well. Virtual Value Chains: The logical outcome of outsourcing strategy is a virtual value chain, where almost all linkages are electronic. Value chain that might once have been contained within a single organization is increasingly being split up across networks of specialist suppliers connected by EDI systems potentially

located across the globe. A linked effect of this is that purchasing is increasingly taking place through websites which also may be located anywhere in this world.

Strategic Alliances: A partnership between two or more firms is commonly known as a strategic alliance. Alliances, including almost all outsourcing agreements, normally involve a legal contract which defines the areas of co-operation
a) Licensing is the allocation of specific rights by one parent firm to a partner.

The partner may be given local manufacturing rights for a patented product or licensed to market locally produced items under the parent firms brand name. In exchange, the parent company receives a royalty payment for each item made or sold.
b) Franchising involves the sharing of profits and ownership between the

parent & a franchisee, who agrees to sell the companys products in a defined format. Typically franchisees shops are owned by independent firms but their owners agree a certain layout and colour scheme for the premises and undertake to sell only goods & services specified by the franchisor.
c) Distribution rights: agents with local geographical knowledge will be given

rights to sell a companys product in return for a commission. This type of arrangement is common in international business.
d) Development agreements: a firm will enter into a memorandum of

understanding with another firm. This sets out what each partner will do to develop a new area of business.
e) Manufacturing agreements are contracts, stipulating that a particular

element of a completed product will be provided by a specific partner organization.

Benefits of alliances: In addition to benefits of outsourcing, alliances can offer a firm the following benefits...

a) Learning from organizations with complementary competences. Some

of the most important alliances span different industries, bringing together different types of knowledge in order to develop new products which no partner firm could have achieved on its own.
b) Being able to penetrate countries that restrict access to part or all of their

economy.
c) Accessing a local partner who knows the accepted ways of doing

business, has the necessary contacts or understands the particular requirements of local customers.
d) Access to organizations with cultures & architectures that promote

creativity & innovation.

Management challenges: The management of external linkages with alliance partners can pose challenges. Trust has to be maintained between the organizations, which may be difficult to do at times when these same firms are potentially in competition with one another for scarce resources and may even be selling products which are substitutes for their collaborators. There is a risk of holdup & possible logistical problem.

Scale of Operations
Organizations face important trade-offs in choosing whether to maximize the scale of an activity, in order to try to get a cost advantage or opt for a smaller, but more expensive, scale of operation. In the latter case it would hope to gain a differentiation advantage by offering a high level of service to a limited set of users. To get the maximum benefit from a large scale operation, it must be intensively utilized. Manufacturing firms will try to use their factories and expensive equipment for two or three shifts every day, stopping only for re-tooling & maintenance. Organizations therefore must decide between a small operation, where capacity may more easily be fully utilized or a larger one which may not be. Lower capacity may offer higher profits & lower risk in the short term, but this must be balanced against the danger that the company will be unable to respond quickly if the market starts to grow strongly.

Scope of Operations
A firm may opt for broad or narrow scope within an activity. An activity can serve a distinct market segment and or set of products and value chain. Sony has specialized marketing & distribution channels for different classes of electronic products, mature & strategic, each managed in a slightly different way to target different customers.

Location Decisions
By choosing the right country or region to locate a particular part of the value chain, a company can get access to local expertise or to low cost resources.

Linkages
One of the most subtle & difficult parts of value chain analysis is the identification of how linkages between different activities can generate value. There are several ways that this can happen... One activity can partially substitute for another. E.g. increasing the amount of training in quality procedures offered to factory workers can lead to reduction in the amount of finished goods inspection and after sales service that is needed. One activity can improve the performance of another. E.g. for a train or bus operator, more frequent maintenance keeps vehicles in better order & improves the reliability of operation. Once activity can generate information that can be used by another. A firm with its own service operations can keep track of customers problems and suggestions and feed them back to the product development activity.

Trade-offs in the value chain

Type of Decision

Different alternatives and their potential advantages

Resources Deployed

Proprietary Potential source of distinctiveness.

Generic Cheap, quick & easy to acquire & update.

Make (hierarchy) Vertical Integration High degree of control of resources and quality, no risk of exploitation, potential for developing distinctive capabilities.

Buy (market) Set-up costs may be lower, flexibility likely to be greater, can profit from suppliers distinctive capabilities & economies of scale.

Scale and Scope

Large scale, broad scope Economies of scale and scope, leverage resources across many products & group of users.

Small scale, narrow niche Achieve specialist excellence in narrow field; avoid wasting resources in places where they are not appropriate.

Everything in one place Location Economies of scale, relatively easy to control & share information & learning.

Distributed Tap into local knowledge & expertise, stay responsive to user requirements, cost advantages.

Linkages

Enable activities to collaborate to meet customers needs in coherent way. Possible source of sustainable advantage.

Types of Value Chain

1. Manufacturing Style Organization 2. Professional Services Organization 3. Network Organizations

1. Manufacturing Style Organization:

These are the kinds of organization where a set of inputs is translated into a set of outputs using a classic path from product development through to after sales service.

2. Professional Services Organization:

These organizations exist to solve difficult problems for individual clients, each of which is likely to require a customized service. E.g. consultancies, educational & scientific research institutions & government departments. Professional services add value by solving their clients problem in a creative & efficient manner. They measure themselves more by the size, prestige & value of the projects they win than the volume of the outputs that they produce.

3. Network Organizations

These are organizations whose main function is the linking of people together. The bigger they are, the more people they link together and the more attractive they become.