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August 7, 2013

Essay on Value Chain

11:42 AM
"The five forces of competition", "value chain" concepts developed by Michael Porter are unavoidable in the case studies of strategy. The first one was introduced in 1982 in the book Strategic Choice and competition. Three years later, the book summarized here uses the value chain to address several fundamental questions about the competitive advantage. How to achieve a sustainable competitive advantage? How interconnections can they enhance a competitive advantage? What are the strategic implications of the corresponding solutions to these two problems? The answers to these three questions are the essence of the book.
Part 1 - Acquisition of competitive advantage
Before entering the heart of the matter, it is necessary to define the concept of competitive advantage. This is what the author describing as "a firm can create value for its customers in addition to the costs incurred by the firm to create." It is therefore crucial for a company to identify its sources of competitive advantage, of course, before the use.
A - A tool for analysis: the value chain
This exploration work is based almost entirely on the use of the value chain as an analytical tool. It outlines the overlap of value-creating activities, distinguishing main activities (inbound logistics, production, outbound logistics, marketing and sales, services) and support (procurement, technology development, human resource management and infrastructure firm).
On the other hand, these activities are related to each other by optimization mechanisms (it may be necessary to arbitrate between two activities) or coordination whose impact on the cost and performance of the firm are significant.
There are also external links (or "vertical"), when the value chain of the company is in contact with those customers suppliers and distributors. It is thus part of a value system (in the terminology of the work).
The different sources of competitive advantage then appear.

One way or another, the latter is reflected by a shift of costs incurred by the firm or by its impact on differentiation.
These two types of competitive activities combined field advantage, on which the company relies to get define three basic strategies to achieve above industry average results. This is the cost leadership, differentiation and activity concentration. However, the latter is particularly insofar as it is based on the operation of a competitive advantage (either by cost or differentiation) within a narrow target.
The author strongly emphasizes the danger that it would refuse to choose between these three basic strategies. According to him, "the stalemate in the middle" inevitably leads to less than the industry average results, except that all competitors commit the same mistake. This should not prevent a firm to reduce costs not involving sacrifice on differentiation or seize opportunities for differentiation are not expensive. Just beyond these adjustments, it must choose the benefit that will ultimately his.
B - The cost advantage
Obtaining such a benefit is possible by exercising creative activities of value to a cumulative cost less than competitors. The value chain is again the preferred instrument by the author to conduct its analysis. It makes it possible to study the costs and value-creating activities rather than the entire firm. It then becomes possible to associate costs and assets in these activities. The resulting comparison can reveal potential cost improvement.
However, it is the analysis of the behavior of costs of activities, and thus their evolutionary factors, which must here attention. These factors are (according to the author) ten in number: economies of scale, learning effects, the configuration of capacity utilization, connections, interconnections, integration, timing, discretionary measures, location and institutional factors. These factors combine to determine the cost of each activity and therefore the position of the firm with respect to the competition.
This work, carried out on the static database, necessarily complete a study of the dynamics of costs. It is this time to predict the direction of change of evolutionary factors and thus identify activities whose costs grow or fall.
In doing so, a company has the means to determine its relative position with respect to costs. Comparison, even approximate, with the situation of its competitors enabling it to choose between getting an advantage by controlling factors of development costs and remodeling the value chain (by improving the design, manufacturing, distribution ...). It is also possible to juggle these two actions. Sustainable cost advantage can also come from a combination of such measures.
Finally, we must not forget that the cost advantage does not lead to better results than the average if the firm offers a value acceptable to the customer.
C - Differentiation
The differentiation achieved by a firm is the value it creates for its customers by meeting all the criteria for purchase.
Sources of differentiation are multiple. They are not only the result of product attributes or trade policy, but all activities of the value chain or downstream activities. It should therefore not be confused with the concept of quality, which is only one component of differentiation.

Strengthening the differentiation arises from the multiplication of uniqueness or singularity which has the firm elements. In fact, the relationship between the value chain of the company and the client are many opportunities for differentiation.
It remains to point out the value created. The customer pays in effect for perceived value. It may even pay a higher value for a lower premium if it is better reported. The success of such a strategy depends much signage criteria (advertising, notoriety) as those of use (actually created value: product quality, delivery ...).
Differentiation gives above average results when perceived by the customer value exceeds its cost. The latter is related to factors of cost trends in the activities that generate the uniqueness of the firm. The performance will be more durable than the customers perceive continuously additional value and that competitors can not imitate. However, we must act with restraint and avoid excessive differentiation or uniqueness and value created assimilate.
Factors affecting both competitive advantage and industry structure
The technology is the first of these. This term covers not only the research and development, but all the technologies used by the company, regardless of their nature (eg it may be a set of procedures). Value chain will therefore once again act as instruments of analysis. His interest is even more important that there are significant interdependencies with customers and technology providers. The distinction between "high" "low" or technology therefore has no interest here. One has indeed the link between technology and competition.

While technology has a direct impact on the cost or differentiation, it operates in a competitive advantage by changing other cost trends or unique factors. It can also affect each of the five competitive forces, particularly at the level of entry barriers. It is therefore necessary to focus on technologies that have the greatest lasting impact on cost or differentiation, which has nothing to do with their degree of sophistication.
Because of this important role in achieving a competitive advantage, we must also consider the evolution of technology. By providing the means to anticipate a firm can take appropriate initiatives and therefore ownership and strengthen competitive advantage.
This work prediction based mostly on the model of the life cycle. In the growth phase, innovations focus on the product. After reaching maturity, the aim is to streamline mass production, where a strong focus on improving manufacturing processes. When approaching the decline, innovations are scarce, technology investments reaching the point of diminishing returns.
However, we must not forget that the forecasts of technology must be considered with caution, as the uncertainty is strong in this area. This recall applies equally to the choice of technologies to be developed for the decision to be or not precursor, or the granting of licenses.

The choice of competitors is the second element to influence both on the competitive structure of the industry and benefit. It can be there at the most interesting chapter of the book since it goes against many ideas. The reasoning is indeed to say that competitors can enhance the competitiveness of the firm and improve the industry structure. It may be better to give up deliberately to increased market share. Things are not so simple, however, since this is how to behave towards "good" competitors, while it should focus attacks on "bad."

Michael Porter explains as follows the benefits of the presence of well-chosen competitors.
Such a competitor may initially act as a shield to the firm, and in several ways. Absorbing fluctuations in demand, it will maintain a high level of activity despite the economic downturn. In serving uninteresting segments, unprofitable, where customers have a considerable bargaining power. Having higher costs, allowing the company to reach a wider margin is a key and is done by stimulating the creative abilities of the basic phenomenon of what the competition.
On a more global level, the presence of competitors avoids prosecution for dominance or monopoly (the example of Microsoft immediately comes to mind). It mainly acts as a deterrent to the entry of a new firm. It makes it more likely the effect of triggering the violent retaliation against a new entrant. This will perhaps already discouraged by the poor state of "good" competitors, which are an illustration of the difficulties faced by firms secondary.
For these effects, we must first determine the characteristics of a good competitor. Basically, it must be credible and consistent in its decisions, but while suffering from weaknesses which it is aware. This limits its ambitions, and therefore the risk that his actions go against the strategy of the firm, but leads to a strategy that strengthens the positive elements of the industry structure. Obviously, no competitor is "good" all the time.
(The same reasoning should be conducted by a firm that is not able to become leader. It will indeed choose one controlled by a "good" leading sector, ie a company whose strategy will benefit a protection behind which the company can live and be profitable.)
The wishing to bring such a configuration of firm competition may initially pursue a policy of deterrence and retaliation collective, focused on the "bad" potential competitors. In contrast, the entry of "good" competitors will be facilitated by concluding supply agreements or distribution or licensing of operating technology.
Whatever the means employed to achieve the ultimate goal in this area is to achieve sufficient market share to deter attack and that, combined with other competitive advantages, preserve market balance.
This part of the book examines the interaction between the field and the competitive advantage held by the firm in a sector. This requires a means to segment and sector factors replacement product.

The segmentation of an area is to determine the competitive field of the firm and therefore the segments it serves.
Differences between products generate segments if they modify the intensity of the five forces of competition or when they affect the conditions for a competitive advantage. Segmentation variables are: product variety, type of customer, the distribution and geographical location. The combination of these variables enables a global segmentation of the sector. Taken two by two, they lead to establish matrices segmentation.
The next step is the competitive strategy, as it is to determine the attractiveness of each of the segments that have been defined. It is of course a function of the structural attractiveness of the segment (measuring the five forces of competition), but also its size, growth, the position of the firm and interconnections (ie links between several segments for which the activities of the value chain can be shared). This last point is absolutely crucial.
Indeed, strong interconnections incentive to develop a strategy consistent with a large target. But the sharing of activities involves coordination costs, compromise (when the value chain is not optimal to serve all segments) and rigidity. It is not always interesting to serve all segments of industry. In this case, the decision to focus on a strategy of concentration by optimizing the value chain to serve one or a few segments.
This strategy will be viable competitors face off target if the optimal value chain (adopted by the firm) is significantly different from that required to serve other segments. By cons, facing imitators, it will only work if the firm enjoys a result of economies of scale (even small and performed in a small segment of sustainable competitive advantage, they help keep the advantage, especially if they can be compensated by interconnections).

The replacement is to replace a product or production method by filling in its place one or more specific functions. This definition is important, since it avoids a mistake method in identifying alternatives. For it is by looking for products with the same generic functions (ie an identical role in the value chain of the customer), and not the same as it should be done.
Moreover, the alternatives are not always different products. The customer can not buy anything for example, deciding to give the corresponding functions. Technical progress, meanwhile, often reduces the rate of use of the product. The use of used products, recycled or reconditioned should not be overlooked. The backward integration (often by buying direct from the manufacturer) is the latest fashion potential replacement. However, the threats come not only in the replacement of alternatives, but also downstream replacements directly affect the customer. A product may be affected by the loss of a complementary product while itself suffers no direct threat.

Replacement of the mechanism results from the combination of three factors. The first is the comparison between the value and the price of the replacement product with the product sector. The author speaks here of relative ratio between value and price (RST areas). The second factor is represented by the conversion costs for the adoption of the replacement product (adoption of new sources of supply, relearning, risk of failure ...). The third is the propensity of customers to switch products (largely dependent on the risk profile or previous replacements).
The evolution of the threat is based on changes in relative prices, the relative value in the value perceived by customers in conversion costs and the propensity to change the product.
These changes determine the path replacement. It starts at a modest pace, it is "and test information" phase. The next phase of "take off" is in the direction of an upper limit established by the number of potentially interested customers, which number may of course vary over time depending on technological developments.

Given the above, a company wanting to launch a replacement product can focus its efforts on customers more willing to change the product, improve its offer in areas where the RST areas is higher, lower conversion costs ... Conversely, the defense of a product may go up by the discovery of new uses for which the replacement has no effect, shift competition away the strengths of the replacement product, or get distributors to contribute to the defense.
Many mistakes can be made in the fight against the alternatives, but the worst is probably the one who is to hold the maturity of the product for granted and so the replacement impossible.
Part 2 - Interconnections and horizontal strategy
The objective here is to describe the overall strategy of a diversified firm. The central issue is the use of interconnections between the units to obtain a competitive advantage.
A - The interconnections between business units
In the 70s, many companies were diversified in the pretext of synergies between their activities. This policy has unfortunately not proved successful, probably because of a lack of judgment in acquisitions or lack of tools of analysis required. This resulted in a new fashion, and the decentralization of activities.
However, the trends observed by Michael Porter led him to recommend the adoption of a horizontal strategy. These divisions coordinate the firm to provide the latter with a comparative advantage. To support his argument, the author is based on four points. First, the 1980s saw a transformation of the mode of diversification: the acquisitions were related fields. Then, growth has slowed significantly, priority is given to the results, and therefore competitive advantage. On the other hand, technological advances facilitate the operation of interconnectors. Finally, only the horizontal strategy provides the necessary global perspective to deal with multipole competitors.

To achieve these results, the author identifies three types of interconnections, which may also coexist.
Tangible interconnections correspond to shared activities between units of the firm. They may involve any creative value and create a competitive advantage through reduced costs or increased differentiation activity. However, they incur costs of coordination, compromise and rigidity.
Intangible interconnections see the transfer of know-how between the value chains of two units. Involving the distribution of the same skills, they often lead to the standardization of basic strategies. Nevertheless, it is a delicate process because knowledge is a very subjective concept.
Interconnections competition finally exist when a firm struggle against rival diversified through several units.
B - The horizontal approach
Diversified firms realize hardly high by simple optimization of the results of their various units overall performance. This applies especially to businesses where decisions are largely decentralized, which affects the operation of interconnectors. In fact, responsible units then formulate their strategies without any consultation and may even move in conflicting directions. To solve this problem, it is necessary to adopt an explicit horizontal strategy.
The latter requires a formulation in several stages. It is first to identify existing interconnections to possibly find outside the firm, to determine those of the competition and finally evaluate their importance for competitive advantage. It then becomes possible to develop a coordinated strategy to exploit horizontal and enhance the most important interconnections.
It is doing so a diversification strategy can increase competitive advantage in sectors already invested or create a sustainable advantage in new areas.

It should however be cautious in seeking interconnections. Should neither neglect nor imagine that any superficial resemblance in technology or procedures is a potential interconnection.
Moreover, even interconnections with a real interest may be difficult to implement. This is the case when the benefits are not (or do not appear) evenly distributed between units. Those responsible for past may also fear a loss of autonomy, especially if widespread culture in the company so far has been a decentralization, with a division for each identity.

To overcome these barriers and these resistances, the author proposes the establishment of a horizontal organization. It interconnects the units within a vertical structure and thus facilitates interconnections. This organization is based on four elements. The horizontal structure is a transverse cut in some areas, the combination of units or partial centralization. The horizontal transverse management systems concern the planning, control and choice of investments. Horizontal human resource practices are intended to facilitate cooperation. Finally, horizontal structures of conflict resolution may be necessary. The combination of these elements horizontal and vertical structure (without match provided a matrix structure) seems sufficiently innovative to the author to talk about a new form of organization.
C - Additional products
This is a special case of interconnection, a product being used to complement other. Additional products are a form of connection between sectors. Their existence requires a choice between three practices.
The direct control of the firm sees complementary products offer comprehensive range of complementary products. It can strengthen a competitive advantage by leveraging interconnections or greater difference through a complete offering. Unfortunately, there is still no interconnections, or certain sectors may not be attractive. Anyway, complementary products are often so numerous that the only solution is to focus on the most strategic of them.
Bundling is he, for sale exclusively in the form of additional block products. Constituting a single whatever answer customer needs, this practice is suboptimal. Interconnections and increased differentiation can certainly make it interesting. However, the risk remains that customers are able to bring themselves to lots of specialized firms offering products with more favorable conditions. That risk tends to increase gradually as customers gain mastery of the technology and therefore the ability to buy piece by piece.
Cross-subsidization, finally sees the company selling a product based on conditions facilitating the sale of more profitable complementary products. This requires sensitivity to high prices for the commodity, but for the good cost low, and a close link between the two. Of course, the customer may not buy the commodity, while the above-mentioned conditions may disappear with the development of the sector. In this case, the company must be prepared to abandon the cross-subsidization.
Part 3 - Strategic Implications
The author concludes this work by developing the impacts of the above reasoning on competitive strategy. It thus provides some evidence on the treatment of uncertainty, as well as offensive and defensive strategies.
A-The role of sectoral scenarios
Until the 1980s, the scenarios developed by firms focused on macroeconomic and macro factors. However, such macroscénarios are not relevant to the analysis of a particular sector. Thus was born the need for sectoral scenarios.
The process to obtain a coherent vision of what could be the future involves several steps. It is first to identify the uncertainties that may affect the structure of the sector and determine the causal factors. The assumptions for these are then combined to arrive at consistent scenarios. It remains to analyze the implications of each scenario (industry structure, sources of competitive advantage or competitive behavior). Of course there are feedback loops between the different phases.

Once the scenarios developed then the five options become available to the company. It can bet on the most likely or that which is the most favorable scenario. It may also choose a viable strategy whatever the scenario is realized (but such a compromise is never optimal) or that maintains enough flexibility until one of the scenarios happen. The last solution is to use its resources to promote the implementation of one of the scenarios.
These solutions are not mutually incompatible, it may be interesting to combine or switch from one to another.
B - The defensive strategies
A strategy to defend against a new entrant is scalable. It is in fact the degree of completion of the latter in its plan of conquest.
Thus, it starts conducting studies to better understand the future market. Then comes the actual entrance, with investments to build a viable position phase. It then continues with the implementation of its long-term strategy. The period after the entry finally leads investments to consolidate its position.
Over the process of entering is advanced, the more barriers to exit are high (because of the financial efforts) and defensive strategy will be costly. The most effective defensive tactics will therefore discourage those attempts, rather than to drive a firm that largely started the process. This requires a strengthening of barriers to entry (filling the existing gaps in the range, increasing conversion costs for customers or increasing capital requirements ...) or by increasing the expectation of response (noting the willingness to defend themselves, clearly showing the possible obstacles, accumulating resources). It is also possible to reduce the incentives to attack by reducing the profit sector.
Anyway, the best defensive strategy is to deter any attack. If it fails, it will certainly go a response strategy, but always with the aim of altering the perception that the new entrant can have sector and its chances of success.
C - The offensive strategies
An offensive strategy should certainly not consist of an imitation political leader, but rather based on a sustainable competitive advantage (either in cost or differentiation). By cons, it will be close to the other leader in value-creating activities. Otherwise, its competitive advantage is not enough to compensate the leader.
In practice, the attacker can operate in three ways.
Remodeling of the value chain allows it to perform certain activities differently. This solution is viable if it proves difficult to imitate for the leader.
Redefining the competitive field will result is a broadening to exploit interconnections or by narrowing to no longer serve a particular target with an optimized value chain.
The first two strategies offer interest often hinder the replica leader, forcing it to go against his usual strategy to defend themselves.
The escalation in spending, finally, is the easiest to design, but also the most risky.
Some concluding comments
If Michael Porter is still a benchmark in the field of strategy, two remarks inevitably come to mind of the reader.
The first relates to the chapters on horizontal strategy and interconnections. The choice of horizontal structures for better coordination may be more appropriate today. It is true that the theory of organizations is subject to fads and that it probably evolved since 1985.
The second point is more critical. Indeed, this book is sometimes like a compendium of known theories which PORTER forgot to mention the names. The approach he proposes, for example, is never a formalization of the SCP paradigm: an analysis of the environment led to the choice of a basic strategy that will (hopefully) superior results to the industry average. The same goes for some of the proposed strategies in the last part. BATH already spoke in 1956 of barriers to entry. Similarly, tactics to increase the expectation of a response by signaling intentions or the accumulation of resources strangely resembles the typology "Big kitties and puppies" of Fudenberg and Tirole, dating from 1984.
In response, the author concedes that all management disciplines contribute to the creation of a competitive advantage, and therefore many authors may have influenced this work.


Anyway, an author being so successful can only provoke much criticism. Include the lack of a clear definition of the models or the lack of empirical data to support his assertions. Some even say that his work is like that because they deceive the reader by the presence of a few simple ideas to understand stereotypes, like "the stalemate in the middle way."

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