The Value Chain and Interlock Strategy

placing orders on suppliers and subsequent deliveries not in sequence with production needs.

A value chain identifies activities, functions and business processes that have to be performed in the designing, producing, marketing, delivering and supporting a product or service. The strategy making lesson of the value chain is that increased organisational competitiveness entrails concentrating resources on those activities where the organisation can gain dominating expertise to serve its target customers. This section examines organisations failures and inability to maximise their value chains, and, suggests the value chain is like an orchestra consisting of a number of links. An orchestra develops its skills and value and there is need to develop an interlock strategy to fully utilise value chains skills and value to its constituent organisations. The design of an interlock strategy is discussed and a number of scenarios identified in order to understand what can be (and needs to be) done by both private and public sector organisations. The ultimate aims of interlock strategy are to reduce costs and increase security of supply as far down the value chains as possible in a turbulent world. An orchestra is a collection of instrumentalists usually containing a substantial string element. The value chain is a collection of interrelated activities or strings. Both the orchestra and the value chain perform to add value. Both can perform well only if they have been assembled correctly and their constituent elements are fully understood. The intelligent orchestra practices and hones its elements to enhance its performance. The value chain once established, is often left to perform and receives little honing or enhancement. Clearly the intelligent value chain needs to learn from orchestral manoeuvres. There is evidence that a well-managed value chain has a significant inverse relationship with average selling price. Organisations that create a greater level of trust among value chain members, communicate future needs, emphasise on time delivery and work throughout the value chain (i.e., beyond tier one) reduce their average selling price compared to competitors (see, e.g., Tan et al., 2002). The typical value chain is based on Michael Porter’s model, shown in Figure 25. Whilst the value chain is understood within (purchasing) organisations, its use beyond the organisation itself is unclear. Many would claim publicly that the Porter model is used throughout their value chain. However, in a credible survey, less than 2% of organisations participate in an “excellent” value chain and, remarkably, only 20% have a value chain strategy. A refreshingly honest view

Figure 25. Porters value chain

Support Activity

O rg In frastructure H um an Resource M anagem ent Technolo gy D evelo pm ent P rocurem ent

Inbound Logistics Operations Sales Marketing Outbound Logistics Service

Prim ary A ctivity

from 44% is that they see themselves as the main barrier, with some 64% of those citing lack of knowledge (training and education) as the primary cause. This all the more remarkable when cost savings, improved quality, accelerated delivery, and improved customer service have been achieved by over 60% of the small minority who have grasped the value chain opportunity. It appears that the notion that suppliers’ value chains do matter; therefore, is not understood in the 21st century. To ignore the notion that costs and margins throughout the value chain are part of the price paid by the end user, whilst wonderfully attractive, is strangely naive (see, for example, Dekker, 2003; Earnst & Young, 2000). Value chains are perceived to fail because of a lack of supplier integrity. In the global arena, they are perceived to fail for a variety of reasons including foreign exchange, quality, political instability, and logistics difficulties. These perceptions come from the purchasing organisation. It’s never their fault. Is it not likely that value chain failures are more often due to not creating alliances within the value chain, not developing a listening system, not encouraging the value chain members to develop partnerships within their value chains, a lack of trust both internally and externally, an inability to broaden vision beyond logistics, and, a lack of genuine leadership? Many organisations have clearly failed to realise the importance of (really) examining their value chains and identifying what is strategic in terms of supply exposure (Rugman, 2001). The strategic elements of the value chain are not too difficult to identify. They are those that are strategically critical and those that affect strategic security. Strategically critical elements have few major sources, no alternatives, may be safety critical and are likely to be high cost. Those that affect strategic security again have few major sources and may be safety critical but are quite possibly low cost. Both elements are likely to be supplied by the purchasers tier one suppliers and the purchaser is likely to abdicate responsibility for continuity and security of supply to that supplier. The abdication is sometime

deliberate, sometimes tacitly, sometimes due to inertia. Overall, such abdication is reckless and naïve. Nevertheless, the need to be competitive and subsequent rush to be global has masked the abdication trait. The rush creates global value chains and with it an even greater tendency to abdicate responsibility for security of supply to tier one suppliers. Global value chains are inherently complex both in advanced economies and developing and transitional economies (Tan et al., 2002). With that complexity, uncertainty exists at every link in the value chain. This natural uncertainty has been enhanced by the tragic events of 11 September 2001. The mindset that drives globalisation is primarily to achieve competitive advantage. Organisations that have high operating costs and little investment in research and development generally pursue global value chains to achieve better quality, on time delivery, lower prices and if they are honest, the development of a problem solving capability or additional technology. Some pursue global value chains however, because “local” suppliers are perceived as incapable; some perceive the former Eastern European countries have a low cost base; some organisations simply want to emulate Japan. Some simply (as indicated previously in this article) do not understand their value chain (Sweeney, 2002). Major organisations have been able to take advantage of relative peace prior to 11 September 2001 to maximise opportunities to purchase goods and services globally. This has created the long and complex value chains that are now threatened by both the worldwide terror campaign and the subsequent military response. The threat has occurred before — the oil crisis of the 1970s, in the Gulf War of the early 1990s, and the Millennium computer bug. None of these threats, although serious at the time, were long term. The war on terror however, appears to be a different proposition. Allied to this threat are other significant business issues. These issues can be categorised into the drive for competitiveness, critical factors that emerge from that drive, and power relationships. The drive for competitiveness is influenced by the instability of the world economic slowdown (which, arguably, was happening before 9/11). Fluctuations in oil and fuel prices and the sheer pace of technological change are relevant factors (Taninecz, 2000). Consequential activity has been opportunistic job losses as well as opportunities for some industries to consolidate in the market place. Critical factors that have emerged include the need to utilise the new technologies and meeting the logistics demands of the 21st century. Delivery on Thursday means delivery on Thursday, not the following Tuesday. These factors alone create pressure and significant hassle and are leading to the return of adversarial business relationships throughout the value chain. Ironically, perhaps, those pressures led to globalisation of value chains in the first place. But what is globalisation? It is generally recognised to be the production and distribution of similar products and services on a worldwide basis — in more simple terms, providing the same output to countries everywhere. Some would argue that the reality is that globalisation has only stretched to the three

continents. North America, Asia, and Europe (see, e.g., Rugman, 2001). In all some 31 nations, however, the United Nations has approximately 189 member nations and FIFA some 200 football (soccer) member nations! The reality is that the largest multinationals are spread across North America, Asia, and Europe. Nevertheless, the war on terror poses a significant threat to both inbound and outbound logistics of companies that operate “globally.” The terrorists themselves will undoubtedly carry out further atrocities that will threaten supply chains as well as kill people. The United States and allied reaction to 11 September 2001 suggests that action will be taken not only in Afghanistan. Countries such as Syria, Iraq, Lebanon, Iran, Colombia, Peru, Palestine, Somalia, Sudan, the Philippines, and Yemen could all be at risk. Europe and the United States are not immune from risk. Are organisations aware of the risk to their value chains? Based on informal contact with regional and national government agencies and with a range of companies in the Dow Jones, NASDAQ, FTSE 100, and Reuters Top 50 Scottish companies, the business priorities of today are security of supply, quality, capability to support, product reliability and time to market. These priorities are very clear, some at the expense of traditional business issues most notably price. It would appear that some organisations have at least recognised the potential threat. Some notable comments include, “Security of supply throughout our supply chain is now paramount, and we’ll have to look more locally for sources of supply”; “We will probably increase centralised procurement to ensure we find more local sources of supply”; “Perhaps we need to look again at our value chain”; “My internal value chain doesn’t add value, so I need to tackle the whole value chain quickly”; and, “I have no idea what happens beyond my tier one suppliers, I had better find out.” Post 11 September 2001, there is arguably serious consideration being given to more “local” sources of supply. The question becomes, what local sources of supply? A parallel question is, are these local sources strategically critical and are we simply creating a strategic security problem in our value chain if we switch to local sources? Before organisations pursue the local source policy, there is a need to examine the value chain. Within the value chain there will be an interlock link, and it is this link that needs most attention from organisations both in the private and public sector. An exemplar interlock strategy grid is shown in Figure 26, using one organisation producing three products and four tiers of the value chain. For the purposes of this discussion, tier one is an original equipment manufacturer (OEM), tier two is a supplier of subassemblies, tier three is a supplier of piece parts, and tier four is a raw material supplier. Service and support of the products are excluded. The grid shows routine single sourcing from tier one. At tier two, supplier 3 supplies all tier one suppliers. At tier three, supplier 4 supplies suppliers 1, 5 and 6 of tier two. At tier four, supplier 5 supplies suppliers 3, 4 and 6 of tier three. In this

Figure 26. The interlock str ategy grid

Product A

Product B

Product C

Tier 1 1 2 3 4 5 6

Tier 2 1 2 4 5 6 3

Tier 3

Tier 4

4 1 2 3 5 6

5 1 2 3 4 6

interlock strategy grid example (for one purchasing organisation’s products) supplier 3 in tier 2, supplier 4 in tier 3 and supplier 5 in tier 4 are critical to the whole value chain. They are the common interlocks. There are a number of scenarios to be examined here.

• Scenario 1. The purchasing organisation needs to evaluate if the respective suppliers in each tier are vulnerable and if the capacities are adequate or need protection. It would appear from the example if any or all of them ceased to exist or supply was interrupted for any length of time, it may not be possible for products A, B and C to be produced. The purchaser could therefore decide to takeover/buy out those suppliers, could decide to establish additional sources of supply and, perhaps, “free issue” material to suppliers to tiers 2, 3 and 4 of the value chain. • Scenario 2. One or more of the suppliers are outside the purchasing organisation’s country. The risk to the value chain needs to be assessed for example, in the context of terrorist attack/war on terror. This could be in terms of the country of origin or the logistics supply network. If the risk is unacceptable, the purchasing organisation should seek to establish a source of supply or additional capacity within its own country.

• Scenario 3. The purchasing organisation is an inward investment company into the host region, state, or nation. Having identified the unacceptable risk, the purchaser seeks assistance from the host regional, state or national government to develop a source of supply. This would apply particularly as part of or an alternative to scenario two. The government motivation is development of its indigenous supply base. • Scenario 4. Neither the purchasing organisation or the government agencies can identify an alternative source of supply within their borders.

The source of supply needs to become a priority target of the government agencies for inward investment — that is attracting the source of supply to their region. • Scenario 5. From a government agency viewpoint, there is no reason for example, if product A, B and C are three separate companies, why they could not work with a range of inward investor organisations to identify interlock suppliers. They could then work with the companies to create additional capacity or if one or more of the sources of supply are not indigenous to the government’s territory, develop a new source of supply.

This could be achieved through investment in the indigenous supply base as part of either local economic development or regeneration agendas. The benefit in terms of new employment is clear. The benefit to inward investment companies of security and continuity of supply (to say nothing of good public relations) is also clear. This raises the question of who should design and execute the interlock strategy? The logical answer within the supply chain is the purchasing function, but much depends on the status of the function with the organisation. Figure 27 highlights the various dichotomies.

Figure 27. How management looks at purchasing (Lysons & Farrington, 2 0 0 5 )

Scope Status Purchasing of of Performance Focus On: Purchasing Purchasing Measures

Purchasing is a Low in Number of orders, clerical function organisation back log, lead Efficiency times, procedures

Purchasing is Reporting to Savings, negotiation a commercial Management contracting, sourcing Efficiency function policy

Purchasing is a Integrated into Supplier development strategic business strategic value chain analysis, function planing process make or buy, Effectiveness e-procurement, outsourcing

Clearly, if the organisation does not see its purchasing function as strategic, there is little point in purchasing taking the lead. Arguably, purchasing should be strategic and in the longer term should both design and execute the interlock strategy. In the short term, a multidisciplinary or cross-functional team would be a feasible option. The team needing to consist of purchasing, quality, and materials engineering and led effectively by a senior manager of the organisation — a value chain analysis project team. An alternative is to outsource value chain management and analysis where the internal skills needed do not exist internally. The interlock strategy needs to become part of every organisation’s risk analysis of their supplier’s portfolio. Indeed, a value chain risk analysis needs to be carried out for every new product. The strategy also needs to become part of regional, state, or national government economic development policy. Quite simply, the supply source needs protecting, developing, or creating. It is clear that when organisations endeavour to produce a viable value chain strategy, there are a number of variables to be taken into consideration. Some are more obvious than others but the scenarios dealt with in this section should help identify the variables. Organisations who take value chain seriously need to be proactive rather than reactive. The rewards are clear — reduced cost and increased security of supply. The interlock strategy of course will become ineffective if those who are operationally responsible are incapable of executing it at the tactical level. In other words, the interlock strategy must ensure that operational capability is commensurate with the strategy. The interlock strategy is about people, expertise, and performance. It is not simply about process. A primary aim of this section is to help both public- and private-sector organisations realise that value chain strategies are important and are not simply an add on to core strategy. There must be a value chain strategy and it must be an integrated strategy. One size does not fit all and scenario planning is important. Organisations need to shift the focus from efficiency to growth and strategic advantage. If this shift does not take place, then organisations are destined for mediocrity and at worst, doomed. Stock markets (worldwide) are beginning to realise this too, and it is one reason that share prices are moving in the negative direction. In the 21st century, organisations need to strive for a triple A supply chain — agility, adaptability and alignment (Lee, 2004). Having provided you with a number of supply chain scenarios, in the next chapter I will discuss managing the supply chain function.