Competitive scope and the value chain of the firm

Competitive scope can have a powerful effect on competitive ad­ vantage, because it shapes the   configuration  and   economics   of the value chain. There are four dimensions of scope that affect the value chain:8

  • 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 strat­-egy.
  • 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 interrela­ tionships between the value chains that  serve different segments, geo­ graphic 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, how­ ever, 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 com­ petitive advantage of a narrow  scope rests on differences among prod­ uct varieties, buyers, or geographic  regions within an industry  in terms of the value chain best suited to serve them,  or on differences in re­ sources and skills of independent firms that  allow them to perform activities better.

The breadth or narrowness of scope is clearly relative to competi­ tors. 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 indus­ tries. 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 inter­ relationships 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 M otors’ value chain for large cars is differ­ ent 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 fundamen­ tal 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, chan­ nels 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 engi­ neering and service capability, or it may  perform  these activities inter­ nally. 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.

W hether or not integration (or de-integration) lowers cost or en­ hances 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.  Interrelation­ ships are also common among partially distinct value chains serving geographic regions in a single country. For example, food service dis­ tributors such as M onarch and SISCO have many  largely distinct operating units in m ajor metropolitan areas that share firm infrastruc­ ture, 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, how­ ever. The   sources   of competitive   advantage  from   a   global   strategy and the impediments to employing one are discussed in Competitive Strategy and elsewhere.10 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 prim ary (e.g., a shared  service organiza­ tion) and support activities (e.g., joint  technology  development  or shared procurement of common inputs). Interrelationships among busi­ ness units are similar in concept to geographic interrelationships among value chains.

Interrelationships among business units can have a powerful influ­ ence 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 shar­ ing. 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 advan­ tages of vertical linkages without  actual  integration,  but  overcoming the difficulties of coordination among purely  independent firms. Be­ cause coalitions involve long-term   relationships,  it   should  be possible to coordinate more closely with a coalition partner than with an inde­ pendent 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 ques­ tion 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 appropri­ ate 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.1

6. Competitive Scope and  Business Definition

The relationship between competitive scope and the value chain provides the basis for defining relevant business unit boundaries. Strate­ gically   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 integra­ tion 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 competi­ tors’ 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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