Industry Value Chains

by Marcus Powe, RMIT's Entrepreneur-in-Residence 

THE MISSING LINK? 

All organisations are in an Industry Value Chain (IVC). Why call it a chain? Each link in the chain represents an organisation in a market, where are you?

An easy way to remember the IVC is to think of the raw materials as a tree. At the other end of the chain is a wooden chair. All the other organisations in between are links in the chain. In this example, there would also be a timber mill, chair manufacturer and the wholesaler. You might be thinking, “How does this model developed by Professor Michael Porter, last century remain relevant?” Wow the Internet!  Strip back the terms and jargon, you still have an IVC.

The IVC is simply a way of drawing the market that an organisation competes in. You may be asking yourself, ‘Why would I bother drawing the marketplace?” The answer is simple – by drawing the market you can see how it works, and the more you can see, the better position you will be in to compete. By drawing an IVC you achieve a greater understanding of how your industry actually works.

The first thing that you need to do is identify where your organisation fits into the chain. Then list all of your organisation’s suppliers and their suppliers to determine the upstream links in the chain. Then do the same for your customers and their customers to determine the downstream links.

It is important to realise that each link in the chain represents a mark-up or margin. Although the raw material may cost a few cents, it then has to be refined (or value added), then distributed, manufactured into a final product and then retailed. And each organisation in the link has to make a profit for them by marking up the product. Once you have determined your position in the IVC, you are then presented with several choices. You could use the information to go about an ‘integration’ strategy – (1) vertical (to acquire a competitor), (2) horizontal (to acquire a supplier or customer) or (3) parallel (to acquire an organisation for their existing distribution channels).

Why do this?

Vertical: to increase your market share, to increase your market presence or to enjoy scale economies. It can also give your organisation benefits it otherwise would not receive, such as shorter delivery times, the need to hold less stock, or ownership of a proprietary technology that you don’t want shared with your competitors. It could also lead to your organisation enjoying larger margins.

Horizontal: Achieving brand leverage by putting all products under the same brand. This would have the effect of reducing your overall marketing expenses, yet still achieve greater advertising through your common brand.

Parallel: If both companies share similar inputs, they then are put through the one supplier, giving the organisation a greater negotiating position, which could result in cheaper raw material costs.

That said, there are several downsides to the parallel integration strategy. A lack of focus for the organisation is the main one. If the acquired organisation is not a viable commercial entity, more time, effort or money will be needed to turn the organisation into a viable entity.

Who has the real power?

You are also able to use the IVC to determine who has the power. If the organisation is in a position of power, it can exercise pressure over companies located both upstream and downstream in the IVC. In exerting power, an organisation can insist on quality standards, impose delivery schedules to minimise their own inventory level, and collaborate to make sure that their innovative product/service features are rapidly introduced. This power translates often into sustainable financial and social dividends.