Linkages within The Value Chain of the firm

1. Linkages within the Value Chain

Although value activities are the building blocks of competitive advantage, the value chain is not a collection of independent activities but a system of interdependent activities. Value activities are related by linkages within the value chain. Linkages are relationships between the way one value activity is performed and the cost or performance of another. For example, purchasing high-quality, precut steel sheets can simplify manufacturing and reduce scrap. In a fast food chain, the timing of promotional campaigns can influence capacity utilization. Competitive advantage frequently derives from linkages among activities just as it does from the individual activities themselves.

Linkages can lead to competitive advantage in two ways: optimization and coordination. Linkages often reflect tradeoffs among activities to achieve the same overall result. For example, a more costly product design, more stringent materials specifications, or greater in-process inspection may reduce service costs. A firm must optimize such linkages reflecting its strategy in order to achieve competitive advantage.

Linkages may also reflect the need to coordinate activities. On- time delivery, for example, may require coordination of activities in operations, outbound logistics, and service (e.g., installation). The ability to coordinate linkages often reduces cost or enhances differentiation. Better coordination, for example, can reduce the need for inven-inventory throughout the firm. Linkages imply that a firm’s cost or differentiation is not merely the result of efforts to reduce cost or improve performance in each value activity individually. Much of the recent change in philosophy towards manufacturing and towards quality—strongly influenced by Japanese practice—is a recognition of the importance of linkages.

Linkages are numerous, and some are common to many firms. The most obvious linkages are those between support activities and primary activities represented by the dotted lines on the generic value chain. Product design usually affects the manufacturing cost of a product, for example, while procurement practices often affect the quality of purchased inputs and hence production costs, inspection costs, and product quality. More subtle linkages are those between primary activities. For example, enhanced inspection of incoming parts may reduce quality assurance costs later in the production process, while better maintenance often reduces the downtime of a machine. An interactive order entry system may reduce salesperson time required per buyer because salespersons can place orders faster and are freed from the need to follow up on inquiries and problems. More thorough inspection of finished goods often improves the reliability of products in the field, reducing servicing costs. Finally, frequent deliveries to buyers may reduce inventory and accounts receivable. Linkages that involve activities in different categories or of different types are often the most difficult to recognize.

Linkages among value activities arise from a number of generic causes, among them the following:

  • The same function can be performed in different ways. For example, conformance to specifications can be achieved through high quality purchased inputs, specifying close tolerances in the manufacturing process, or 100 percent inspection of finished goods.
  • The cost or performance of direct activities is improved by greater efforts in indirect activities. For example, better scheduling (an indirect activity) reduces sales force travel time or delivery vehicle time (direct activities); or better maintenance improves the tolerances achieved by machines.
  • Activities performed inside a firm reduce the need to demonstrate, explain, or service a product in the field. For example, 100 percent inspection can substantially reduce service costs in the field.
  • Quality assurance functions can be performed in different ways.  For example, incoming inspection is a substitute for finished goods inspection.

Though linkages within the value chain are crucial to competitive advantage, they are often subtle and go unrecognized. The importance of procurement in affecting manufacturing cost and quality may not be obvious, for example. Nor is the link between order processing, manufacturing scheduling practices, and sales force utilization. Identifying linkages is a process of searching for ways in which each value activity affects or is affected by others. The generic causes of linkages discussed above provide a starting point. The disaggregation of procurement and technology development to relate them to specific primary activities also helps to highlight linkages between support and primary activities.

Exploiting linkages usually requires information or information flows that allow optimization or coordination to take place. Thus, information systems are often vital to gaining competitive advantages from linkages. Recent developments in information systems technology are creating new linkages and increasing the ability to achieve old ones. Exploiting linkages also frequently requires optimization or coordination that cuts across conventional organizational lines. Higher costs in the manufacturing organization, for example, may result in lower costs in the sales or service organization. Such tradeoffs may not be measured in a firm’s information and control systems. Managing linkages thus is a more complex organizational task than managing value activities themselves. Given the difficulty of recognizing and managing linkages, the ability to do so often yields a sustainable source of competitive advantage. The specific role of linkages in cost and differentiation will be discussed in more detail in Chapters 3 and 4.

2. Vertical Linkages

Linkages exist not only within a firm’s value chain but between a firm’s chain and the value chains of suppliers and channels. These linkages, which I term vertical linkages, are similar to the linkages within the value chain—the way supplier or channel activities are performed affects the cost or performance of a firm’s activities (and vice versa). Suppliers produce a product or service that a firm employs in its value chain, and suppliers’ value chains also influence the firm at other contact points. A firm’s procurement and inbound logistics activities interact with a supplier’s order entry system, for example, while a supplier’s applications engineering staff works with a firm’s technology development and manufacturing activities. A supplier’s product characteristics as well as its other contact points with a firm’s value chain can significantly affect a firm’s cost and differentiation. For example, frequent supplier shipments can reduce a firm’s inventory needs, appropriate packaging of supplier products can lower handling cost, and supplier inspection can remove the need for incoming inspection by a firm.

The linkages between suppliers’ value chains and a firm’s value chain provide opportunities for the firm to enhance its competitive advantage. It is often possible to benefit both the firm and suppliers by influencing the configuration of suppliers’ value chains to jointly optimize the performance of activities, or by improving coordination between a firm’s and suppliers’ chains. Supplier linkages mean that the relationship with suppliers is not a zero sum game in which one gains only at the expense of the other, but a relationship in which both can gain. By agreeing to deliver bulk chocolate to a confectionery producer in tank cars instead of solid bars, for example, an industrial chocolate firm saves the cost of molding and packaging while the confectionery manufacturer lowers the cost of in-bound handling and melting. The division of the benefits of coordinating or optimizing linkages between a firm and its suppliers is a function of suppliers’ bargaining power and is reflected in suppliers’ margins. Supplier bargaining power is partly structural and partly a function of a firm’s purchasing practices.5 Thus both coordination with suppliers and hard bargaining to capture the spoils are important to competitive advan- tage. One without the other results in missed opportunities.

Channel linkages are similar to supplier linkages. Channels have value chains through which a firm’s product passes. The channel markup over a firm’s selling price (which I term channel value) often represents a large proportion of the selling price to the end user—it represents as much as 50 percent or more of selling price to the end user in many consumer goods, such as wine. Channels perform such activities as sales, advertising, and display that may substitute for or complement the firm’s activities. There are also multiple points of contact between a firm’s and channels’ value chains in activities such as the sales force, order entry, and outbound logistics. As with supplier linkages, coordinating and jointly optimizing with channels can lower cost or enhance differentiation. The same issues that existed with sup-pliers in dividing the gains of coordination and joint optimization also exist with channels.

Vertical linkages, like linkages within a firm’s value chain, are frequently overlooked. Even if they are recognized, independent ownership of suppliers or channels or a history of an adversary relationship can impede the coordination and joint optimization required to exploit vertical linkages. Sometimes vertical linkages are easier to achieve with coalition partners or sister business units than with independent firms, though even this is not assured. As with linkages within the value chain, exploiting vertical linkages requires information and modem information systems are creating many new possibilities. I will discuss the role of supplier and channel linkages in competitive advantage more fully in Chapters 3 and 4.

3. The Buyer’s Value Chain

Buyers also have value chains, and a firm’s product represents a purchased input to the buyer’s chain. Understanding the value chains of industrial, commercial, and institutional buyers is intuitively easy because of their similarities to that of a firm. Understanding households’ value chains is less intuitive, but nevertheless important. Households (and the individual consumers within them) engage in a wide range of activities, and products purchased by households are used in conjunction with this stream of activities. A car is used for the trip to work and for shopping and leisure, while a food product is consumed as part of the process of preparing and eating meals. Though it is quite difficult to construct a value chain that encompasses everything a household and its occupants do, it is quite possible to construct a chain for those activities that are relevant to how a particular product is used. Chains need not be constructed for every household, but chains for representative households can provide an important tool for use in differentiation analysis, to be discussed in more detail in Chapter 4.

A firm’s differentiation stems from how its value chain relates to its buyer’s chain. This is a function of the way a firm’s physical product is used in the particular buyer activity in which it is consumed (e.g., a machine used in the assembly process) as well as all the other points of contact between a firm’s value chain and the buyer’s chain. Many of a firm’s activities interact with some buyer activities. In optoelectronic parts, for example, a firm’s product is assembled into the buyer’s equipment—an obvious point of contact—but the firm also works closely with the buyer in designing the part, providing ongoing technical assistance, troubleshooting, order processing, and delivery. Each of these contact points is a potential source of differentiation. “Quality” is too narrow a view of what makes a firm unique, because it focuses attention on the product rather than the broader array of value activities that impact the buyer.

Differentiation, then, derives fundamentally from creating value for the buyer through a firm’s impact on the buyer’s value chain. Value is created when a firm creates competitive advantage for its buyer—lowers its buyer’s cost or raises its buyer’s performance.6 The value created for the buyer must be perceived by the buyer if it is to be rewarded with a premium price, however, which means that firms must communicate their value to buyers through such means as advertising and the sales force. How this value is divided between the firm (a premium price) and the buyer (higher profits or more satisfaction for the money) is reflected in a firm’s margin, and is a function of industry structure. The relationship between the buyer’s value chain and the firm’s value chain in creating and sustaining differentiation will be described in detail in Chapter 4.

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

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