Competitive scope and the value chain of the firm

Competitive scope can have a powerful effect on competitive advantage, because it shapes the configuration and economics of the value chain. There are four dimensions of scope that affect the value chain:

  • Segment Scope. The product varieties produced and buyers served.
  • Vertical Scope. The extent to which activities are performed in-house instead of by independent firms.
  • Geographic Scope. The range of regions, countries, or groups of countries in which a firm competes with a coordinated strategy-
  • Industry Scope. The range of related industries in which the firm competes with a coordinated strategy.

Broad scope can allow a firm to exploit the benefits of performing more activities internally. It may also allow the firm to exploit interrelationships between the value chains that serve different segments, geographic areas or related industries.9 For example, a shared sales force may sell the products of two business units, or a common brand name may be employed worldwide. Sharing and integration have costs, however, that may nullify their benefits.

Narrow scope can allow the tailoring of the chain to serve a particular target segment, geographic area or industry to achieve lower cost or to serve the target in a unique way. Narrow scope in integration may also improve competitive advantage through the firm’s purchasing activities that independent firms perform better or cheaper. The competitive advantage of a narrow scope rests on differences among product varieties, buyers, or geographic regions within an industry in terms of the value chain best suited to serve them, or on differences in resources and skills of independent firms that allow them to perform activities better.

The breadth or narrowness of scope is clearly relative to competitors. In some industries, a broad scope involves only serving the full range of product and buyer segments within the industry. In others, it may require both vertical integration and competing in related industries. Since there are many ways to segment an industry and multiple forms of interrelationships and integration, broad and narrow scope can be combined. A firm may create competitive advantage by tuning its value chain to one product segment and exploiting geographic interrelationships by serving that segment worldwide. It may also exploit interrelationships with business units in related industries. I will discuss these possibilities in more detail in Chapter 15.

1. Segment Scope

Differences in the needs or value chains required to serve different product or buyer segments can lead to a competitive advantage of focusing. For example, the value chain required to serve sophisticated minicomputer buyers with in-house servicing capabilities is different from that required to serve small business users. They need extensive sales assistance, less demanding hardware performance, user-friendly software, and service capability.

Just as differences among segments favor narrow scope, however, interrelationships between the value chains serving different segments favor broad scope. General Motors’ value chain for large cars is different from that for small cars, for example, but many value activities are shared. This creates a tension between tailoring the value chain to a segment and sharing it among segments. This tension is fundamental to industry segmentation and to the choice of focus strategies, the subject of Chapter 7.

2. Vertical Scope

Vertical integration defines the division of activities between a firm and its suppliers, channels, and buyers. A firm may purchase components rather than fabricate them itself, for example, or contract for service rather than maintain a service organization. Similarly, channels may perform many distribution, service, and marketing functions instead of a firm. A firm and its buyers can also divide activities in differing ways. One way a firm may be able to differentiate itself is by assuming a greater number of buyer activities. In the extreme case, a firm completely enters the buyer’s industry.

When one views the issue of integration from the perspective of the value chain, it becomes apparent that opportunities for integration are richer than is often recognized. Vertical integration tends to be viewed in terms of physical products and replacing whole supplier relationships rather than in terms of activities, but it can encompass both. For example, a firm may rely on a supplier’s applications engineering and service capability, or it may perform these activities internally. Thus there are many options regarding what value activities a firm performs internally and what value activities it purchases. The same principles apply to channel and buyer integration.

Whether or not integration (or de-integration) lowers cost or enhances differentiation depends on the firm and the activity involved. I have discussed the factors that bear on this question in Competitive Strategy. The value chain allows a firm to identify more clearly the potential benefits of integration by highlighting the role of vertical linkages. The exploitation of vertical linkages does not require vertical integration, but integration may sometimes allow the benefits of vertical linkages to be achieved more easily.

3. Geographic Scope

Geographic scope may allow a firm to share or coordinate value activities used to serve different geographic areas. Canon develops and manufactures copiers primarily in Japan, for example, but sells and services them separately in many countries. Canon gains a cost advantage from sharing technology development and manufacturing instead of performing these activities in each country. Interrelationships are also common among partially distinct value chains serving geographic regions in a single country. For example, food service distributors such as Monarch and SISCO have many largely distinct operating units in major metropolitan areas that share firm infrastructure, procurement, and other support value activities.

Geographic interrelationships can enhance competitive advantage if sharing or coordinating value activities lowers cost or enhances differentiation. There may be costs of coordination as well as differences among regions or countries that reduce the advantage of sharing, however. The sources of competitive advantage from a global strategy and the impediments to employing one are discussed in Competitive Strategy and elsewhere.16 The same principles apply to national or regional coordination of value chains.

4. Industry Scope

Potential interrelationships among the value chains required to compete in related industries are widespread. They can involve any value activity, including both primary (e.g., a shared service organization) and support activities (e.g., joint technology development or shared procurement of common inputs). Interrelationships among business units are similar in concept to geographic interrelationships among value chains.

Interrelationships among business units can have a powerful influence on competitive advantage, either by lowering cost or enhancing differentiation. A shared logistical system may allow a firm to reap economies of scale, for example, while a shared sales force offering related products can improve the salesperson’s effectiveness with the buyer and thereby enhance differentiation. All interrelationships do not lead to competitive advantage. Not all activities benefit from sharing. There are also always costs of sharing activities that must be offset against the benefits, because the needs of different business units may not be the same with respect to a value activity. I will describe interrelationships among business units and their implications for both corporate and business unit strategy in Chapters 9-11.

5. Coalitions and Scope

A firm can pursue the benefits of a broader scope internally, or enter into coalitions with independent firms to achieve some or all of the same benefits. Coalitions are long-term agreements among firms that go beyond normal market transactions but fall short of outright mergers. Examples of coalitions include technology licenses, supply agreements, marketing agreements, and joint ventures. Coalitions are ways of broadening scope without broadening the firm, by contracting with an independent firm to perform value activities (e.g., a supply agreement) or teaming up with an independent firm to share activities (e.g., a marketing joint venture). Thus there are two basic types of coalition— vertical coalitions and horizontal coalitions.

Coalitions can allow sharing of activities without the need to enter new industry segments, geographic areas, or related industries. Coalitions are also a means of gaining the cost or differentiation advantages of vertical linkages without actual integration, but overcoming the difficulties of coordination among purely independent firms. Because coalitions involve long-term relationships, it should be possible to coordinate more closely with a coalition partner than with an independent firm, though not without some cost. Difficulties in reaching coalition agreements and in ongoing coordination among partners may block coalitions or nullify their benefits.

Coalition partners remain independent firms and there is the question of how the benefits of a coalition are to be divided. The relative bargaining power of each coalition partner is thus central to how the gains are shared, and determines impact of the coalition on a firm’s competitive advantage. A strong coalition partner may appropriate all the gains of a shared marketing organization through the terms of the agreement, for example. The role of coalitions in competitive advantage is discussed in my book on global strategy, because they are particularly prevalent in international competition.11

6. Competitive Scope and Business Definition

The relationship between competitive scope and the value chain provides the basis for defining relevant business unit boundaries. Strategically distinct business units are isolated by weighing the benefits of integration and de- integration and by comparing the strength of interrelationships in serving related segments, geographic areas, or industries to the differences in the value chains best suited for serving them separately. If differences in geographic areas or product and buyer segments require very distinct value chains, then segments define business units. Conversely, strong and widespread benefits of integration or geographic or industry interrelationships widen the relevant boundaries of business units. Strong advantages to vertical integration widen the boundaries of a business unit to encompass upstream or downstream activities, while weak advantages to integration imply that each stage is a distinct business unit. Similarly, strong advantages to worldwide coordination of the value chains imply that the relevant business unit is global, while strong country or regional differences necessitating largely distinct chains imply narrower geographic busi- ness unit boundaries. Finally, strong interrelationships between one business unit and another may imply that they should merge into one. Appropriate business units can be defined, then, by understanding the optimal value chain for competing in different arenas and how the chains are related. I will return to this issue after the principles of industry segmentation have been discussed in Chapter 7.

7. The Value Chain and Industry Structure

Industry structure both shapes the value chain of a firm and is a reflection of the collective value chains of competitors. Structure determines the bargaining relationships with buyers and suppliers that is reflected in both the configuration of a firm’s value chain and how margins are divided with buyers, suppliers, and coalition partners. The threat of substitution to an industry influences the value activities desired by buyers. Entry barriers bear on the sustainability of various value chain configurations.

The array of competitor value chains is, in turn, the basis for many elements of industry structure. Scale economies and proprietary learning, for example, stem from the technology employed in competitors’ value chains. Capital requirements for competing in an industry are the result of the collective capital required in the chain. Similarly, industry product differentiation stems from the way firms’ products are used in buyers’ value chains. Thus many elements of industry structure can be diagnosed by analyzing the value chains of competitors in an industry.

Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.

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