SM Chapter-6 - Value Chain

8/6/2019 SM Chapter-6 - Value Chain

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Chapter – 6

Value Chain Analysis

The basic idea of value chain is quite simple, and is based on the chain of eventsthat 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

Which assets & capabilities an organization chooses to use in

connection with specific activities.

Vertical IntegrationWhether the organization decides to carry out an activity itself,or to outsource it to a specialist supplier or a franchisee.

Scale of Operations

Whether an organization tries to gain economies of scale, or other types of advantage, from the scale of its operations in aparticular activity.

Scope of OperationsWhether an organization tries to share one or more activitiesacross different products & markets

Location of Operations

In which country of region an organization chooses to locateparticular activities

Linkages Whether the organization tries to gain advantage by linking itsactivities together in a new & different way.



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

firm’s 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.





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 firm’s 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 company’s 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 givenrights to sell a company’s 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 hold-

up & possible logistical problem.

Scale of OperationsOrganizations 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 hasspecialized 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 customer’s 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.

Vertical Integration

Make (hierarchy)

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.

Location

Everything in one place

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 client’s 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.



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SM Chapter-6 - Value Chain