Letter V

V
Valuation: A concept commonly used in the context of a merger. The value of the company being acquired must be established carefully. There are various ways to value a company – market price of shares, replacement cost of assets, present value of the future expected cash flows, etc. Ultimately, valuation is a subjective exercise that is as much art as science.
(See Merger)

Value Chain: A framework developed by Michael Porter for analyzing the various activities a firm performs to create value for its customers. By analyzing the value chain, the firm can understand how it is adding value, in which activities it is strong, where it is weak and how it can further streamline the value addition process.

The value chain breaks down the firm into various activities in order to understand the behavior of costs and the existing or potential sources of differentiation. A firm gains competitive advantage by performing these activities more cheaply or better than its rivals.

Value is the amount buyers are willing to pay for what a firm provides them. A firm is profitable if the value created exceeds the costs incurred. Creating value for buyers that exceeds the cost of doing so, is the goal of any generic strategy.

Value chain activities can be categorized into Primary & Support.

Primary Value Chain Activities include:

• Inbound logistics: Receiving, warehousing, and inventory control of input materials.

• Operations: Activities that transform the inputs into the final product.

• Outbound logistics: Comprise the activities that get the finished product to the customer, including warehousing, order fulfillment, etc.

• Marketing & Sales: Activities that try to persuade buyers to purchase the product, including channel selection, advertising, pricing, etc.

• Service: Activities like customer support, after sales service, etc.

One or more of these primary activities may be vital in developing a competitive advantage. For example, logistics activities are critical for a retail chain. Marketing may be a critical activity for a company offering branded consumer goods.

Support Activities include:

• Procurement: Purchasing the raw materials and other inputs used in the value-creating activities
• Technology Development: Activities like research and development and process automation.
• Human Resource Management: Activities like recruiting, development, and compensation of employees.
• Firm Infrastructure: Activities such as finance, legal services, and management information systems

Porter emphasizes that a firm’s value chain must be viewed as an interdependent system or network of activities, connected by linkages. Linkages occur when the way in which one activity is performed, affects the cost or effectiveness of other activities. Linkages often create trade-offs in performing different activities that must be optimized. For example, more expensive components can reduce after-sale service costs.

Linkages also require activities to be coordinated. Coordinating linked activities reduces transaction costs, allows better information for control purposes, substitutes less costly operations in one activity for more costly ones elsewhere and can also reduce cycle time. For example, dramatic time savings can be achieved through such coordination in the design and introduction of new products and in order processing and delivery.

The value chain can help managers understand the sources of cost advantage. Many managers view cost too narrowly and concentrate on manufacturing. They also need to look at product development, marketing and service and draw cost advantage from throughout the value chain. Gaining cost advantage also usually requires optimizing the linkages among activities as well as close coordination with suppliers and channels.

The value chain also helps identify the sources of differentiation. Differentiation results, fundamentally, from the way a firm’s product, associated services and other activities affect its buyer’s activities. The various points of contact between a firm and its buyers, offer scope for differentiation.

The value chain allows a deeper look not only at the types of competitive advantage but also at the role of competitive scope in gaining competitive advantage. Scope shapes the nature of a firm’s activities, the way they are performed and how the value chain is configured. By selecting a narrow target segment, a firm can tailor each activity more precisely and effectively to the segment’s needs compared to competitors with broader scope. On the other hand, broad scope may lead to a competitive advantage if the firm can share activities across industry segments or even when competing in related industries.

The current trend is towards smaller and more focused value chains. The idea is to help companies focus on core competencies and leave the remaining activities to partners with specialized expertise. What is becoming critical is excellent capability in a small section of the value chain. Taiwanese semiconductor companies, for example, concentrate on manufacturing. They do not generally get involved in design or marketing. Nike concentrates on brand management and outsources most of its manufacturing. In the PC industry, we have companies like Intel (microprocessors), Samsung (monitors), HP (printers), Microsoft (operating systems) and Mitec (modems) offering specialized products.

As value chains fragment, the ability to coordinate value chain activities performed by different entities has also become important. The chain as a whole must perform effectively and provide value to customers in a superior way. Effective coordination depends crucially on trust and relationships between the orchestrator and the different entities involved. Information Technology can facilitate coordination but cannot take the place of trust.
(See Process Networks, Supply Chain Management)

Value Migration: Companies are in business to create value for the customer. They can do this by offering a product or service that corresponds to customer needs. In a fast changing business environment, the factors that determine value are constantly changing. As Adrian Slywotzky mentions value migration is the shifting of value-creating forces. Over time, value migrates from outmoded business models to business designs that are better able to satisfy customers' priorities. That is when established players find it difficult to compete and the circumstances become ripe for challengers.
(See Adrian Slywotzky)

Value System: A term coined by Michael Porter. A firm's value chain is linked to the value chains of upstream suppliers and downstream buyers. The result is a larger stream of activities known as the value system. The development of sustainable competitive advantage depends not only on the firm’s value chain, but also on the value system of which the firm is a part. In a manner of speaking, value system is equivalent to the supply chain.
(See Supply chain management, Value Chain)

Values: The set of principles which a company regards as sacrosanct. These principles are non negotiable and cannot be compromised. Values may refer to the company’s philosophy vis-à-vis customers, suppliers, society and investors. Values define what is right, what is wrong and what are the priorities. Values guide employees while taking decisions.
(See Core Ideology)

Vertical Integration: The expansion of a business by acquiring or developing businesses engaged in earlier or later stages of the value chain. For example, in forward integration, manufacturers might enter retailing while, in backward integration, retailers might enter manufacturing.

All firms are vertically integrated to some extent. Arriving at the optimum level of vertical integration involves examination of important trade offs. Outsourcing increases flexibility but vertical integration gives the company a greater sense of control. The most important issue in outsourcing is deciding which resources or capabilities are core and strategic. If such competencies are not developed in-house, the long-term competitive position of the firm would be threatened. For example, the research efforts of global pharmaceutical companies involve tremendous risk, but cannot be outsourced. This is because research forms the basis for competition in the pharmaceuticals business. What a company does in-house and what it outsources has significant strategic implications for the company. One of the best examples is IBM. In a bid to get its PC project going fast, the computer giant decided to entrust the development of the operating system to Microsoft. The rest, as we know is history.

Michael Porter has offered deep insights on vertical integration .

Benefits of vertical integration include:
A. Economies of integration: By combining technologically distinct operations, there are opportunities for reducing the number of steps in the production process, handling and transportation, and consequently the costs of scheduling and co-ordinating. Integrated operations can reduce information gathering, marketing and purchasing costs. Upstream and downstream stages can take a long term view and develop specialized procedures for dealing with each other in areas like logistics, packaging, record keeping and control. Vertical integration also allows the upstream unit to tune its product to the exact requirements of the downstream unit and for the downstream unit to adapt itself more fully to the characteristics of the upstream unit.

B. Technological advantages: A unit may integrate forward to understand the technology in the downstream business. Similarly, it may integrate backwards to familiarize itself with the technology in the upstream business.

C. Assured supply/demand: Vertical integration can hedge the firm against fluctuations in supply/demand.

D. Offsetting bargaining power: Vertical integration can allow the firm to reduce the bargaining power of powerful suppliers or customers. Further, by gaining a better understanding of costs, the firm has opportunities to improve its profitability.

E. Ability to differentiate: By manufacturing proprietary items in house and exercising greater control on the channels of distribution, etc., the firm can increase the scope for differentiation.

F. Creation of entry barriers: The more significant the net benefits of integration, the greater the pressure on new entrants to integrate. As a result, the entry barriers increase.

G. Entry into a high return business: Integration may allow the company to enter a more profitable part of the value chain.

Costs

A. Exit barriers: Integration often increases strategic interrelationships and emotional ties to the business. Some commitments are irreversible. As a result, exit barriers are raised.

B. Increased operating leverage: Vertical integration increases fixed costs. When an input is produced internally, the firm has to bear the overheads even during downturns.

C. Reduced flexibility to change partners: Technological changes, changes in product design involving components, etc can create a situation in which the in house supplier may be providing a high cost, inferior or inappropriate product. It is not easy to switch to an outside supplier at short notice.

D. Capital Investment requirements: Vertical integration consumes capital resources which have an opportunity cost.

E. Foreclosure of access to supplier/consumer research: By integrating, the firm may cut itself off from the flow of technology from its suppliers or customers.

F. Imbalances: When the upstream and downstream units are not balanced, potential problems arise.

G. Inefficiencies: Since buying and selling occurs through a captive relationship, the incentive to perform may be less for both the upstream and downstream businesses, resulting in inefficiencies.

H. Different managerial requirements: Businesses can differ in structure, technology and management despite having a vertical relationship. For example, manufacturing and retailing are fundamentally different. Understanding how to manage these different activities, can be a major cost of integration.

John Hagel III and Marc Singer offer a very useful framework for resolving the vertical integration dilemma, by examining the coordination problems which arise when different players are involved in a value chain activity. When the interaction costs can be reduced by performing an activity internally, a company will vertically integrate rather than outsource. Reduction in interaction costs leads to a shakeout in the industry and changes the basis for competitive advantage. The emergence of information technology in general and the internet in particular has dramatically lowered interaction costs. So, the chances are that specialized players will hold the aces.

Hagel and Singer add that there are three different core processes which are integral to any business. These are customer relationship management, product innovation and infrastructure creation. The competencies needed to manage them are quite different.

Customer relationship management focuses on attracting and retaining customers. It involves big marketing investments that can be recovered only by achieving economies of scope. A wide product range and a high degree of customization to suit the needs of different customers are the critical success factors in customer relationship management.

Product innovation aims at bringing out attractive new products and services to the market in quick succession. Speed is important because early mover advantages are often critical. Small organizations with an entrepreneurial style of management are often better at innovation than large bureaucracies.

Infrastructure creation (like an Information Technology backbone) is necessary to handle high volume repetitive transactions efficiently. Economies of scale are vital for recovering fixed costs. Standardization and reutilization are the essence of this process.

When these three processes are combined within a single corporation, conflicts are bound to arise. Scope, speed and scale cannot be achieved simultaneously. So, many industries like newspapers, credit cards and pharmaceuticals are splitting along these lines.

There are alternatives to vertical integration. A firm can resort to partial integration. Independent suppliers can be used to bear the risk of market fluctuation while in house suppliers maintain steady production rates.

Another alternative is Quasi Integration. This refers to a relationship between vertically related businesses that are somewhere in between long term-contracts and full ownership. There can be various forms of quasi integration.

i) Minority equity investment
ii) Loans or loan guarantee
iii) Prepurchase credits
iv) Exclusive dealing agreements
v) Co-operative R & D.

Quasi integration tends to reduce the costs associated with full integration. It also avoids the need to make major capital investments required for integration and eliminates the complexities involved in managing other types of businesses. On the negative side, quasi integration may fail to achieve the full benefits of integration such as differentiation.
(See Backward Integration, Forward Integration)

Value Innovation: A term coined by Chan Kim and Renee Mauborgne. Smart companies focus on new markets which Kim and Mauborgne call blue oceans, pursuing a strategy called value innovation. Instead of fighting competitors, these companies try to make them irrelevant by creating a leap in value for buyers and the company, thereby opening up new and uncontested business opportunities, called Blue Oceans.

Value innovation places equal emphasis on value and innovation. Value without innovation tends to be incremental and does not give the company a competitive edge in the marketplace. Innovation without value tends to be technology-driven, market pioneering, or futuristic, often shooting beyond what buyers are ready to accept and pay for. Value innovation occurs only when companies align innovation with utility, price and cost positions. Companies that seek to create Blue oceans, often pursue differentiation and low cost simultaneously.

Buyer value comes from the utility and price that the company offers to buyers. The value to the company is determined by the price and the cost structure. So value innovation is achieved only when the utility, price and cost activities are properly aligned. Such an integrated approach holds the key to the successful implementation of a Blue ocean strategy.
(See Blue Ocean Strategy).

Vision: A guiding theme that articulates the nature of the business and its intentions for the future. These intentions are based on how the management believes the environment will unfold and what the business can and should be in the future. A vision has the following characteristics: (1) informed – rooted in a deep understanding of the business and the forces shaping the future, (2) shared and created through collaboration, (3) competitive – creates an obsession with winning throughout the organization, and (4) enabling – empowers individuals to make meaningful decisions about strategies and tactics. A vision must be able to inspire people by making a powerful statement in simple terms so that people at all levels can relate to it.
(See Corporate Purpose, Mission)