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  activi­ ties just as it does from the individual activities themselves.

Linkages can lead to competitive advantage in two ways: optimiza­ tion 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 link­ ages reflecting its strategy   in   order  to   achieve   competitive   advan­ tage.

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 abil­ ity to coordinate  linkages often reduces  cost or enhances  differentia­ tion. 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. M uch of the recent change in philosophy towards m anufacturing and towards qual­ ity—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 m anufacturing cost of a prod­ uct, for example,   while procurement  practices often   affect the quality of purchased inputs and hence production costs, inspection costs, and product quality. M ore subtle linkages are those between primary activi­ ties. 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 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 o f direct activities is improved by greater efforts in indirect 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 For example, 100 percent inspection can substantially reduce service costs in the field.
  • Quality assurance functions can be performed in different 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 m anufacturing  cost  and  quality may not be obvious, for example. N or is the link between order processing, manufacturing scheduling practices, and sales force utilization. Identi­ fying 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 pro­ curement and technology development to relate them to specific pri­ mary 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 coor­ dination 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 m anufacturing 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 inspec­ tion 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 m anufacturer 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 bar­ gaining 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 im portant 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 owner­ ship 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 mod­ em information systems are creating  many  new possibilities. I will discuss the role of supplier and channel linkages in competitive advan­ tage 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  house­ holds’ value chains is less intuitive, but nevertheless important.  House­ holds (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 every­ thing 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   im portant  tool for use in differentiation analysis,   to   be   discussed   in   more  detail   in   Chap­ ter 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 opto­ electronic 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 differ­ entiation will be described in detail in Chapter 4.7

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

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