Understanding Your Value Chain

(linkages between disrupted technologies and life-cycles)

There is a recurring pattern that helps explain why organisations so often make strategic errors in choosing where to focus their efforts and resources. Considering these questions will help you understand:

Where attractive profits will be earned in the value chain of the future?

Under what circumstances integrated organisations will wield powerful competitive advantages?

What changes in circumstances will shift competitive advantage to specialised, non-integrated organisations?

What causes an industry to fragment?

How can a dominant, integrated organisation determine what to outsource and what to hold on as its industry begins to break into pieces?

How can new entrants figure out where to target their efforts to maximise profitability?

Disrupted technologies framework

Innovations are divided into 2 categories: sustaining and disruptive

- sustaining - provide better quality or additional functionality that can involve incremental improvements to break-through products and services. Most innovations are included in this category

- disruptive - not necessarily meeting existing customers' needs and/or not like currently-available product and services. They are like being an uninvited guest at someone else's party, ie stand out in a crowd and grab the attention. They are typically simpler, more convenient and less expensive, so that they appeal to a new customer base. Usually disruptive innovations have a major impact on the industry structure. Some examples include

- the biro which replaced the "fountain pen" as a cheaper writing instrument despite its initial technical problems, eg it leaked and produced a lower quality of writing;

- Southwest Airlines' low-cost flights that initially attracted leisure travellers with limited disposable income, and later on attracted the more up-market customers;

- lap-top computers were not as powerful as mainframe computers but were considerable cheaper and more convenient

- Google has revolutionised the advertising and software industry

- Bill Gates invented the software industry

- the dislocation impacted upon Kodak by digital photography was that Kodak went out of business

- Steve Jobs has on several occasions used disruptive technologies to change the direction of an industry. Some examples
- in 1977, Apple 11 kicked off the PC era;

- in 1994, the graphical user interface launch by Macintosh;

- in 2007, Apple put the smart phone (iPhone) on the market

"...Along the way Jobs conceived of 'desktop publishing', gave the world the laser printer, and pioneered personal computer networks...... he bankrolled Pixar, which fosters the technology and a brand-new business model for creating computer-animated feature films......he elbowed aside the likes of Sony to change the dynamics of consumer electronics with iPod. He persuaded the music industry, the television networks, and Hollywood to let him show them how to distribute their wares in the digital age with iTunes music stores. He employed......his hugely successful Apple stores to give the big box boys a lesson in high-margin, high-touch retailing.....Jobs orchestrated Apple's over the top entry into cellular phone business with the iPhone..."

Geoff Colvin, 2007

Jobs has reinvented 5 industries (computers, movies, music, retailing and wireless phones). Furthermore, he has had an impact on the creative side of all industries with software tools, sound recording and photo editing

This framework helps predict how an industry will change as customers' needs are exceeded and provides a useful indicator of

- where competition will arise under these circumstances

- where the money will be made in the future in the industry's shifting value chain

Money will not be made by outsourcing activities organisations should be hold onto and, conversely, holding onto activities they should unload.

Organisations compete at different stages of a product's life-cycle. For example, when a product's functionality does not yet meet the needs of key customers, organisations are forced to compete on the basis of product performance. Later, as the underlying technology improves and mainstream customers' needs are met, organisations are forced to compete on the basis of convenience, customerisation, price and flexibility.

These different bases for competition call for very different organisational structures at both the organisation and industry level

"...when products aren't yet good enough for mainstream customers, competitive pressures force engineers to focus on wringing the best possible performance out of each succeeding product generation by developing and combining proprietary components in ever more efficient ways...... when the product is not good enough, backing off from the best you can do spells competitive trouble. To make the highest performing products possible, then, companies typically need to adapt interdependent, proprietary product architectures......when the product isn't good enough, in other words, being an integrated company is critical to success..."

Clayton M Christensen et al in AFR, 2002

For example, in the early days of the computer industry, mainframes were not powerful enough to satisfy customers' needs and the way the machines were designed depended on the way they were manufactured, etc. Thus, an independent supplier would not survive because of the interdependence of the different components such as operating systems, core memory, logic circuitry, etc. That is why the most integrated organisation thrived in the early development of an industry, such as IBM in the computer industry, Ford and General Motors in the automotive industry, Xerox in the photocopier industry, when the products

- did not satisfy the customers' needs

- were based on the sorts of proprietary interdependent value chains that are necessary way of pushing the frontier of what is possible.

However, once product performance improves beyond the needs of the general customers, the way to compete changes. For example, there is a need for more flexible products, to market faster and to customise products to meet the needs of even smaller market niches. This means organisations need to design modular products, in which the interfaces between components and sub-systems are clearly specified.

Once a modular architecture and requisite industry standards have been defined, integration is no longer critical to an organisation's success. In fact, integration can become a competitive disadvantage in terms of speed, flexibility and price.

The same

"...forces that support integration in the early years of an industry are those that alternately pull an industry apart into component pieces..."

Clayton M Christensen et al as quoted by AFR, Jan 11 2002

In deciding whether to outsource or not, 3 conditions must be met

1 Specifiability - need to know what to specify - what attributes of the activity/item being procured are critical and which are not

2 Verifiability - must be able to measure those attributes in order to verify that what has been received is what is needed

3 Predictability - cannot be any unpredictable interdependencies, ie understand how the sub-system will perform with the other systems already in place

The above are pre-requisites for modular design to work efficiently

Organisations competing in an integrated marketplace face very different challenges from those competing in a fragmented market. Furthermore, sources of profitability change. For both cases, the bedrock principle is

"...those who control the interdependent links to a value chain capture the most profit..."

Clayton M Christensen et al as quoted by AFR, 2002

When product functionality is not adequate, integrated organisations that design and make end-use products typically make the most money; the 2 reasons for this are:

i) interdependent, proprietary architecture of their products makes differentiation straightforward

ii) the high ratio of fixed to variable costs creates steep economies of scale

Once large integrated players overshoot what the mainstream customers can use, fragmentation occurs with profitability switching to specialist organisations, such as makers of components and sub-systems. At that stage, the large integrated organisations come under investor pressure to increase the returns on assets. As they cannot differentiate their products or make them at lower costs than competitors, they tend to sell off asset-intensive units that design and manufacture components to other organisations. These later organisations see the opportunity to create sub-systems whose architectures are progressively more interdependent - thus improving the Return on Assets.

(sources: Clayton M Christensen et al, 1995, 2002 & 2006; Geoff Colvin, 2007)