Intangible interrelationships among business units

Intangible interrelationships  lead   to   competitive   advantage through the transfer of skills among separate value chains. Through operating one business unit, a firm gains know-how that  allows it to improve the way another  generically   similar business   unit competes. The transference of skills can go in either direction— e.g., from existing business units   to   a new   business unit  or from   a new business unit back to existing business units. The  transference  of generic know-how can occur anywhere in the value chain. Philip Morris transferred gen­ eric know-how in the marketing  of  consumer  packaged  goods from its cigarette business to Miller Beer, while Emerson Electric transferred plant design and cost reduction  skills when it acquired  the chain saw firm Beaird-Poulan.  In both cases, the transference  of skills changed the way that the receiving business unit competed and enhanced its competitive advantage.

Intangible interrelationships  lead   to   a   competitive   advantage if the improvement in cost or differentiation in the business unit receiving the know-how exceeds the costs of transferring  it. Know-how  residing in one business unit  has already been   paid   for,   and   hence transfer­ ring   it may involve little cost compared  to   its cost of development. The actual transference of know-how always involves some cost, how­ ever,   whether  it be the cost of time of skilled   personnel  or perhaps the greater risk that proprietary information will leak out. Using the know-how that is transferred will also typically involve some cost in adapting it to the circumstances of the receiving business unit. These costs of transferring know-how must be weighed against the potential benefits to determine whether an intangible interrelationship will create competitive advantage.

Intangible interrelationships are im portant to competitive advan­ tage when the transference of know-how or skills allows the receiving business   unit   to   lower   costs   or   enhance  differentiation.   This   occurs if the   transference   of skills   leads   to   policy   changes  that  lower cost or enhance differentiation,   or because the   transference  of skills gives the receiving business unit better  insight into its other drivers of cost or uniqueness. The transference of skills from Philip Morris  to Miller Beer, for example, resulted in policy changes  in the way beer was positioned and marketed, as well as an escalation of advertising spend­ ing that  increased   scale   economies   in   the   industry  and   worked  to the advantage of large brands like Miller.

Identifying Intangible Interrelationships. Intangible interrela­ tionships arise from a variety of generic similarities among  business units:

  • same generic  strategy
  • same type of buyer (though not the same buyer)
  • similar configuration of the value chain (e.g., many  dispersed sites of mineral extraction and processing)
  • similar im portant value activities (e.g., relations with govern­ ment)

Although value activities cannot  be shared,  these similarities among business units mean that  know-how  gained   in   one   business unit is valuable and transferable to another.

Because of the myriad possible generic similarities among business units, it is not possible to be as complete in identifying the important types as it was with tangible interrelationships.  However, the value chain provides a systematic way of searching for intangible interrela­ tionships. A firm can examine the m ajor value activities in its business units to unearth similarities in activities or the way the chain is config­ ured that might provide the basis for transference of know-how  or highlight generic skills that might be applied to new industries.

Intangible Interrelationships and  Competitive Advantage.   Intan­ gible interrelationships  of one type   or   another  are   very   widespread. It is always possible to point to some generic similarity in some value activity between almost any two business units. An airline is widely dispersed, has multiple sites, and relies heavily on scheduling, charac­ teristics shared by trucking companies, international trading companies and industrial gas producers.  W idespread  similarities of some kind make the analysis of intangible interrelationships quite subtle.

The key tests in identifying intangible interrelationships that are important to competitive advantage are the following:

  • How similar are the value activities in the business units?
  • How important are the value activities involved to competition?
  • How significant is the know-how that  would   be   transferred to competitive advantage in the relevant activities?

These questions  must  be answered  together.  The  similarity of two business units is a function of how much know-how can be usefully transferred. The importance of the transferred  know-how  is a function of its contribution to improving competitive advantage in the receiving business unit. The  transference of just one insight can sometimes make an enormous  difference to competitive  advantage,  so even business units that are not very similar can have im portant intangible interrela­ tionships. However, truly im portant intangible interrelationships  are much  less common  than  an initial   search   for them   might  imply.   It is frequently   difficult,   moreover,   to   predict  whether  the   transference of know-how will prove to be valuable.

The most common pitfall in assessing intangible interrelationships is to identify generic similarities among business units that  are not important to competition. Either the know-how that can be transferred does not affect value activities that are im portant to cost or differenti­ ation in the receiving business   unit,   or   it does   not  provide insights that  competitors  do not  already have.   Philip   M orris’s acquisition of the Seven Up soft drink company provides a possible example of the latter. While the beer industry  had  historically been   populated   by family firms   with   little marketing  flair,   the soft drink  industry has long been characterized by sophisticated  marketing  by the likes of Coke, Pepsi, and D r Pepper. Philip M orris’s marketing  expertise ap­ pears to have offerred   much  less of an   advantage  for Seven Up than it did for Miller.

Many firms have fallen into the trap of identifying intangible interrelationships that are illusory or do not m atter for competitive advantage. Often, it   seems,   intangible   interrelationships  are   forced, and represent more  of an ex poste rationalization  of diversification moves undertaken for other reasons. Intangible interrelationships were prominent in discussions of synergy. The difficulty of finding and imple­menting significant intangible interrelationships is one of the reasons synergy proved such a disappointment to many firms.

The effective exploitation of intangible interrelationships thus re­ quires an acute understanding  of the   business units   involved   as well as the industries they compete in. The importance of an intangible interrelationship for competition can only be truly understood by iden­ tifying specific ways in which know-how  can be transferred  so as to make a difference. The mere hope that one business unit might learn something useful from another is frequently a hope not realized.

Even intangible interrelationships  where  the benefits of transfer­ ring know-how far exceed the cost of transferring it do not lead to competitive advantage unless the transference  of know-how  actually takes place. Know-how is transferred through interchange between managers or other personnel in the affected business units. This process does not occur without active efforts on the part of senior management. Personnel in the receiving business   unit  may   be   wary   or   unsure  of the value of know-how from a “different” industry.  They  may even openly resist it. Business units with know-how  may be hesitant  to commit the time of im portant  personnel  and  may view the know­ how as highly proprietary. Finally, transference of know-how is subjec­ tive and the benefits of doing so often are hard for managers to under­ stand when compared to tangible interrelationships.  All these factors imply that even im portant intangible interrelationships can be very difficult to achieve. Doing  so requires  a sustained  commitment and the existence of formal mechanisms through which the required trans­ ference of skills will take place. A   conducive  organizational  setting can greatly reduce the cost of transferring know-how.

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

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