Article Review 640

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Evolving From Value Chain to Value Grid

Breaking free of linear

chain thinking and

viewing value creation

from a multidimensional

grid perspective provides

the greatest opportunities

for innovation.

Frits K. Pil and

Matthias Holweg

*ention the term value chain, and most managers will have visions of a neat

sequence of value-enhancing activities. In the simplest form of a value chain,

raw materials are formed into components that are assembled into final prod-

ucts, distributed, sold and serviced. Frequently, these activities span multiple organizations. This orderly progression allows managers to formulate profitable strategies

and coordinate operations. But it can also put a stranglehold on innovation at a time when the greatest opportunities for value creation (and the most significant threats to long-term

survival) often originate outside the traditional, linear view. Traditional value chains may have worked well for landline telecommunications and

automobile production during the last century, but innovation today comes in many shapes and sizes – and often unexpectedly. (See “About the Research,” p. 75.) This argues for see-

ing value creation as multidirectional rather than linear.1 Given the constant tension

between opportunity and threat, companies need to explore opportunities for managing risks, gaining additional influence over customer demand and generating new ways to cre-

ate customer value. Mobile phone giant Nokia Corp., for example, is legendary for having had the foresight to lock in critical components that were in short supply, allowing it to

achieve significant market share growth. However, Nokia suffered a setback a few years ago when competitors used that very same strategy to take advantage of shifts in the demand for

LCD displays. Protection against such fickle reversals calls for a more complex view of value – one that

is based on a grid as opposed to the traditional chain. The grid approach allows companies to move beyond traditional linear thinking and industry lines and map out novel opportu-

nities and threats. This permits managers to identify where other companies – perhaps

even those engaged in entirely different value chains – obtain value, line up critical resources or influence customer demand. In a value-grid framework, there are a variety of new pathways to enhanced performance.

They can be vertical (as companies explore opportunities upstream or downstream from the adjacent tiers in their existing value chain), horizontal (as companies identify opportu-

nities from spanning similar tiers in multiple value chains) or even diagonal (as companies look more integratively across value chains and tiers for prospects to enhance performance

and mitigate risk). Successful companies increasingly develop a multifaceted value-Grid perspective as they leverage new opportunities and respond to new threats.’ (See “Value-

Grid Dimensions and Strategies,’ p. 74.)

Frits K. P/1 is an associate professor at the Katz Graduate School of Business and a research scien- tist at the Learning Research Development Center, both at the University of Pittsburgh. Matthias Hol- weg is a senior lecturer at the Judge Business School at the University of Cambridge, UK, and a research affiliate at the MIT Center for Technology, Policy, and lndustrial Development. They can be reached at fritspil@pitt,edu and holweg@mit.edu.

72 MIT SLOAN MANAGEMENT REVIEW SUMMER 2006 111ustration: o jim rrazierlimages.com

Thinking Nonlinearly Within the Chain Companies seek competitive advantage with value chains by managing an orderly flow of goods and services across supplier and customer relationships. In theory at least, reducing the lead time at each link in the chain allows companies to reduce inven- tory and deliver the end products using concepts such as just-in- time manufacturing and supply, continuous replenishment and quick-response manufacturing. Doing away with decision-mak- ing tiers in turn cuts coordination costs and improves informa- tion flow. As the entire chain tightens, the company becomes more

competitive.3

However, there is a catch: How benefits are distributed across the value chain depends heavily on the balance of power between suppliers and manufacturers. This is where nonlinear thinking comes in. The strategy focus needs to shift from lead-time reduc- tion to the power dynamics between the company and other

players in the chain. Thus, companies need to focus on three areas: (1) opportunities to influence customer demand both upstream and downstream, (2) opportunities to modify infor- mation access in either direction, and (3) opportunities to explore penetration points in multiple tiers that are not immedi- ately adjacent. These types of opportunities emerge from think- ing nonlinearly within the traditional value chain, which constitutes the vertical dimension of the value grid.

Influencing Demand Companies try to control demand both down- stream (in the direction of the end-user or customer) and upstream in their value chain (in the direction of their suppliers and their suppliers’ suppliers). In controlling downstream demand, companies essentially control who drives the purchase decision in the supply chain. Customers typically generate demand for some intermediate products. Intel Corp., for example, tries to increase demand and shore up its prices by making com- puter buyers more aware of its chip sets, while Nokia works hard to get its logos affixed to the cell phones it sells to wireless service providers. According to a Nokia executive, the company sees its brand image as the primary driver of customer retention – even more than its reputation for technology leadership. Mobile serv- ice providers such as Verizon and Sprint in the United States, Japan’s DoCoMo and UK-based Orange push back by giving pref- erential treatment to handset providers who agree to remove their logos and customize handsets for the service provider.

The value-grid approach recognizes that companies cannot always control or influence the customer directly, so it takes a broader perspective on how to control where the purchase deci- sion is made. Companies can explore the full value chain, identi- fying – and sometimes inserting – levers that will shift decisions from one point to another. The pharmaceutical indus- try offers a case in point. Clearly, the end-user in this industry is the patient who takes a drug, but who drives the decision on which drug to purchase is less obvious. To deal with this ambigu- ity, pharmaceutical companies often take a three-pronged approach in targeting key decision points. The first prong is aimed at consumers. The industry invests more than $2 billion annually on direct-to-consumer marketing (almost 10% of what it spends on research and development). But focusing on con- sumers is only partly effective. The National Institutes of Health estimates that only about one in 10 consumers who see adver- tisements for medicines request a specific drug from their physi- cian. While this figure may seem unimpressive, the advertising prompts a larger group of patients to discuss their concerns with their healthcare provider, thus increasing the overall demand for a particular class of drugs.

The second prong is aimed at physicians, getting them to become more aware of conditions that specific drugs are intended to treat. For example, GlaxoSmithKline Inc. lends

SUMMER 2006 MIT SLOAN MANAGEMENT REVIEW 73

spirometers to primary-care practices so that physicians can con-

duct breathing tests themselves rather than referring patients to

pulmonologists for testing. GlaxoSmithKline uses this opportu-

nity to provide doctors with information on inhaled corticos-

teroids. The hope is that greater use of spirometry tests will result

in increased identification of subtle respiratory problems, which

in turn will generate more demand for medications such as those

that the company produces. When medications from multiple pharmaceutical companies

can be used to treat a condition, drug companies face obstacles in

shifting demand to their particular drug. The last prong involves

incentives for physicians and pharmacies. By strategically manip-

ulating discounts and exclusivity arrangements, pharmaceutical

companies try to persuade physicians to prescribe their products.

Failing that, they attempt to redirect prescriptions to a drug that

they produce, going as far as to insert pharmacy benefit managers

strategically into the value chain. (Pharmacy benefit managers

act on behalf of insurance companies to negotiate discounts for

their plan participants.) Merck & Co., Inc., for example, acquired

The grid perspective highlights three dimensions for identi-

fying ways to enhance company performance: the vertical,

horizontal and integrative diagonal dimensions. Within the

vertical dimension, companies explore nonlinear opportuni-

ties in their traditional value chain by looking beyond those

directly connected to them upstream or downstream.

Within the horizontal dimension, companies explore opportunities in parallel value chains. Within the diagonal

dimension, companies take an integrative approach as

they explore more widely in other tiers and value chains

for opportunities to create value. For ease of exposition, the value grid figure here is simple

and rendered in two dimensions. It should be noted that

companies undertaking a thorough mapping of the value

grid will find many more cross-linkages and relationships.

After initial opportunities have been exploited, the poten-

tial landscape for identifying opportunities can be continu-

ously enlarged.

UPIrl-al

PRIMARY INPUTS (Raw Materials, Services, etc.)

Diagonal Dimension

Medco Health Solutions in 1993 for this precise purpose.

Medco, which was spun off in 2003 amid complaints about its

role pushing Merck products, currently manages prescription

drug plans representing more than 60 million patients. To qual-

ify for discounts, participants must select from a preferred list

of medicines. In exchange for getting their products on the pre-

ferred list, pharmaceutical companies provide additional

rebates to the pharmacy benefit managers. Pharmacy benefit

managers effectively limit the number of channels and avenues

by which patients can obtain their medications and frequently

cut out traditional pharmacies. For example, Medco negotiates

with clients such as General Motors Corp. to have plan partici-

pants purchase maintenance drugs from a mail-order unit.

Indeed, the GM plan no longer permits plan participants to fill

their prescriptions through pharmacies such as Walgreen Co.’s

Walgreens. In addition to influencing demand downstream, companies

have opportunities to influence price sensitivity and volume

demand upstream. Consider Pfizer Inc. Its statin drug Lipitor,

which is designed to reduce levels of so-called “bad” cholesterol,

is the world’s top-selling medicine and accounted for sales of

$12.2 billion in 2005. However, in anticipation of the loss of its

patent protection in 2010, Pfizer is testing a new cholesterol drug,

torcetrapib, which is intended to increase the amount of “good”

cholesterol and potentially complement Lipitor’s role in slowing

the development and progression of atherosclerosis.

Pfizer is assessing torcetrapib’s effectiveness and safety – not

as a stand-alone intervention but as used in conjunction with

Lipitor. The company is not testing torcetrapib with the other

well-known statins, which are produced by its competitors. If the

clinical trials are successful, torcetrapib will be available only as

part of an integrated combination pill with Lipitor. This provides a good example of how companies can look

upstream, in this case to R&D efforts, to identify ways to narrow

customer choice downstream. In this particular instance, there is

also a potential bonus for end-users: By having Lipitor and torce-

trapib in one pill, they may be able to obtain two drugs for a sin-

gle copay.

Modifying Information Access Real opportunities for shifting the buy- ing decision occur when companies are able to link information

with control. (See “Knowledge-Retention Strategies by Network

Role.”) For example, a company needs to understand its suppliers’

1’v1stre””n flexibility and pricing structure. Companies can do a better job in

this area by monitoring the market conditions faced by suppliers.

* For example, American Honda Motor Co. Inc., unlike some of its

Japanese competitors, offers contracts to suppliers that specify

* which second-tier suppliers will furnish components for the sub- END-USERS assemblies integrators provide. The greatest value comes when

suppliers view this level of control as being in their own interest as

74 MIT SLOAN MANAGEMENT REVIEW SUMMER 2006

well. In 2002, the U.S. government’s steel safeguard program

imposed tariffs of up to 30% on certain types of imported steel.

This caused prices of U.S.-produced steel to jump dramatically, which in turn made it difficult to procure certain grades of steel.

Most automakers now purchase steel in volume, which they resell

to their suppliers at a discount. The benefit to automakers is not

just lower cost but also the ability to learn more about their sup-

pliers’ material costs and control a key input for direct suppliers.

For companies such as Nokia that cannot directly control the

product offering, having information about end-users is critical. It

is standard for mobile network operators to provide phone service

with handsets, tying the price of the phone to the service contract.

In reaction, Nokia developed a mechanism for communication

with its users in Europe, the Middle East and Africa – a Web site called Club Nokia, where customers get priority support and

exclusive offers and services if they register their phones. Nokia

went so far as to offer special ring tones directly through this site, a practice it discontinued only after service providers complained.

Exploring Multitier Penetration As companies find ways to control

over-demand, they often assume multiple positions in the value

chain in order to diversify demand and limit a particular buyer’s

power. For example, Bosal International NV, headquartered in Lummen, Belgium, manufactures original equipment exhaust

systems for auto manufacturers. However, it also sells extensively in the aftermarket. The company sees its business holistically: By

examining the multiple points in the value chain where it can

participate, it can explore scale economies in design and produc-

tion. In the late 1990s, for example, there was intense pressure

from original equipment manufacturers to reduce costs and

Knweg-eeto Strteie by Network*Rol-

Dimension

Vertical

Horizontal

Diagonal

I~~~~~~ Abu h*Rsac

This article is based on a structured investigation of value

chain strategies in a range of industry sectors, supported

by the Cambridge-MIT Institute’s Centre for Competitive-

ness and Innovation, the International Motor Vehicle Pro-

gram at MIT and the Sloan Foundation. Our initial impetus

for undertaking the research was a comprehensive map-

ping of the value chains and value creation strategies of

nine vehicle manufacturers, their suppliers and their logis-

tics operations. The automotive industry is widely noted

for its operational effectiveness, and our initial efforts pro-

vided us with a comprehensive picture of the value chain

strategies at each tier. This enabled us to assess the effec-

tiveness and the risks inherent in the linear thinking asso-

ciated with current value chain strategies.

In a second step, we turned toward the fast-moving

telecommunications sector, where we conducted a series

of structured and semistructured interviews with execu-

tives of hardware manufacturers, software providers and

national telecommunications operators. Contrasting the

automotive and telecom sectors, we developed our basic

framework articulating the three core dimensions of

value-grid thinking.

In a third step, we explored how nonlinear strategies

are used in other sectors. We drew on interviews in health-

care and pharmaceutical-related settings and a host of

other industries to refine and validate our value- grid

model and identify a set of generic strategies for leverag-

ing value-grid thinking.

and

SUMMER 2006 MIT SLOAN MANAGEMENT REVIEW 75

increase the steel quality of exhaust systems. Although supplying

OEMs was important for credibility, the aftermarket offered

Bosal more attractive margins.

The balance is now shifting. Because exhaust systems are built

to last longer, they are replaced later in a vehicle’s life cycle. This has

led to greater price sensitivity in the aftermarket and fewer sales.

However, tighter emission standards and other factors now favor

OEM suppliers such as Bosal that offer integrated solutions. To

leverage its aftermarket experience, Bosal has shifted investment

away from aftermarket exhausts to less-price-sensitive accessories

such as tow and roof bars and the emerging catalytic converter

aftermarket. By supplying more than one tier in the value chain,

Bosal is less vulnerable to specific changes in demand and more

able to capture high-margin opportunities as they emerge.

Thinking nonlinearly about demand also helps companies

identify customer solutions that fall outside the traditional value

chain. In the auto sector, for example, steel providers typically ship

steel coils to vehicle manufacturers, which stamp them into auto

By moving beyond the linear value chain, companies can gen-

erate value for the customer by joining or integrating addi- tional value chains. There are several ways in which this type

of integration is playing out in the telecom sector. (See “The Convergence of Voice Services.”)

Although mobile phone use has taken off, mobile calls are

traditionally much more expensive than landline calls. Land- line manufacturers are working on mobile handsets that link into the landline at home and into the global system for

mobile communication (GSM) network outside the home, thus

providing a novel value proposition for consumers. BT Group’s

BT Fusion, offered in collaboration with mobile provider Voda-

fone Group, is a mobile handset that functions as a normal mobile phone but links at home to a landline, using Bluetooth short-range radio (see option A in the figure). The customer

needs only one handset and pays low landline charges in addi-

tion to mobile network charges.

Voice over Internet Protocol (VoIP) companies like Luxem- bourg-based Skype Ltd. and New Jersey-based Vonage offer

Internet telephony to households by providing voice commu- nication between users of the Internet and landline telephone

infrastructure – seizing part of the landline infrastructure’s

value in the process. Corporations have embraced VoIP as a way to save on landline phone calls, but they are still faced

with the high cost of cell phone calls.

As wireless Internet access becomes more ubiquitous, the

solution will be to integrate VoIP and wireless fidelity (WiFi). A

voice signal sent over IP is transmitted through a WiFi connec-

tion (VoWiFi). With current collaborations between VoIP and

body components that get welded and painted. Prior to painting, the assembled auto body receives an electrocoat to protect it against corrosion. Dusseldorf, Germany-based steel producer ThyssenKrupp AG has developed a new coating that protects steel against both chipping and corrosion. This coating has the poten-

tial to eliminate a significant chunk of the painting process at assembly plants, thereby allowing manufacturers to operate

smaller, more flexible factories and produce finished vehicles at lower cost. In the automotive market, where product life cycles are getting shorter and product variety continues to increase, this change has the potential of offering a considerable advantage.

Exploiting Parallel Value Chains Within the value grid’s vertical dimension, companies often look

for new opportunities within a single value chain as they seek new ways to influence demand, obtain critical information or

penetrate the value chain at multiple points. By contrast, the opportunities for change in the horizontal dimension typically

WiFi providers, individuals can make calls wirelessly much

more cheaply than over traditional mobile networks. Dublin-

based Cicero Networks combines a VoWiFi capability in

hotspots coupled with a GSM capability for its business cus-

tomers, as most mobile phone calls originate from business

premises (see option B in the figure). Using dual-mode

GSM/WiFi handsets or pocket PCs, customers can make calls

over the cheaper WiFi base stations when these are available

and not congested by other WiFi users, and over GSM other-

wise. WiFi networks increasingly threaten mobile network

operators in urban areas, where WiFi density is high. A further

boost to voice service convergence may occur with WiMAX, a

variant on WiFi, which spans several square miles.

Yet another opportunity to integrate value is found by

linking the fixed and VoIP communication value chains to

enhance options and cost propositions. The USB DUALphone,

made by wireless communication supplier RTX, based in

Noerresundby, Denmark, is a cordless phone for home use

that can be used either as an IP or a traditional public

switched telephone network (PSTN) phone (see option C in

the figure). Still absent from the market is a handset that

integrates VoWiFi, GSM and landline access (see option D in

the figure). With GSM capability now integrated in a single

chip and increasing coverage of WiFi base stations, however,

this is a viable proposition. Instant text and video messaging,

interactive gaming and other interactive applications, cash

equivalency storage, streaming Internet access, browsing and data sharing further enrich the potential to integrate value in

this particular arena.

“76 MIT SLOAN MANAGEMENT REVIEW SUMMER 2006

reside in multiple value chains. This dimension provides oppor- tunities for companies to leverage economies of scale across mul- tiple sources of demand. Consider the case of an auto supplier that makes flexible printed circuit boards. If the supplier is able to sell its circuit boards to companies making medical and office automation equipment, it can generate greater sales across which

to spread its costs. The potential of the value grid’s horizontal dimension goes beyond economies of scale and scope in that it enables companies to manage risk, seize existing value, integrate sources of existing value and explore novel ways to create value.

Managing Risk In most industries, demand patterns tend to be cyclical. Fluctuations are fairly common, which might cause companies to underuse capacity or fail to supply demand, thus prompting customers to look at competing products.

Looking across value chains provides companies with an opportunity to explore countercyclical demand patterns. For example, Honda is famous for its high-quality engines, but demand for some motor vehicles, such as motorcycles, is sea-

sonal. To stabilize demand for motorcycle engines, Honda uses those engines in counterseasonal products, such as lawnmowers,

go-carts and snowblowers. Similarly, the engines that power the Honda Accord, CR-V and Element also power Honda’s 135HP outboard motors. Honda leverages its core expertise in engine design and benefits by achieving economies of scale in engine production and design. It spreads the demand and development risks for a component across multiple value chains and level

demand by operating in value chains with orthogonal (for exam- ple, offsetting) demand and risk patterns.

Seizing Value In order to build more value, companies are becom- ing more aggressive about moving horizontally into the value chains of other companies in their industry. This entails using a similar production or service stage in other value chains as a pen- etration point into those chains. Toyota, for example, is the world leader in hybrid powertrain technology, yet it has chosen to license this technology to Ford and Nissan – two direct com- petitors – even though demand for its own hybrid vehicles out- paces its production capacity.

According to traditional linear thinking about value, Toyota is unwise because its engines are key to differentiating some of its products downstream and enabling the company to charge premium prices. From a horizontal perspective, however, the engine is a product in its own right. Toyota is more than a vehi- cle purveyor; it is an influential supplier to other vehicle pro- ducers. By supplying others, Toyota not only gains economies of scale but also helps to establish and control the technological framework for future hybrid vehicle development across the

industry.

The greatest opportunities – and perhaps the greatest threats

Breaking free of linear mind-sets is enabling the telecommunications sector to identify a number of novel opportunities for delivering value to its customers. By inte- grating the value proposition across the three basic value chains associated with the landline telephone, the cell phone and the Internet, companies are developing a number of per- mutations of service and price bundles for end-users.

COMBINATORY OPTIONS AT THE CUSTOMER INTERFACE

NETWORK INFRASTRUCTURE

LANDLINE (PSTN)

Switched SignialI

CELL PHONE NETWORK

0 Landline

Packet Signal 0o Cell phone

DATA LINE (VOICE OVER IP) Packet Signal 0

PC

A. Bluetooth

& CSM

B. VoWiFi

&GSM

C. VolP

&Landiine,

D. VolP,

Landline & GSM

– occur when companies think horizontally in an attempt to control value. This often takes place when a company identifies a component or service that yields disproportionate profitability

and then introduces that element into other companies’ value chains. Disposable printer cartridges are a good example of this. Many printer manufacturers sell their printers at or near cost in the hope that ink, toner cartridges and paper will generate a rev- enue stream later on. Like the proverbial razor company, they count on being able to sell disposable cartridges at regular inter-

vals. However, this scenario was threatened when small busi- nesses began offering refilled cartridges at substantial discounts.

Traditional printer manufacturers, including Hewlett-Packard

Co. and Lexmark International Inc., took defensive steps to com- bat the challenge. Lexmark added to its toner cartridges an elec- tronic chip that can communicate with the printer as a way to ensure that the replacement cartridges would be Lexmark prod- ucts. The company offered discounts on cartridges with embed- ded chips, believing that only Lexmark would be able to refill or remanufacture them. However, the company was wrong, and independent companies succeeded in supplying compatible car- tridges. After pursuing legal challenges that ultimately failed, Lex- mark changed its strategy and began supplying printer cartridges

for other brands of printers.

Lexmark’s solution raises an interesting point about horizon- tal thinking: When companies in or across industries modularize a particular component or service in the value chain, other com-

SUMMER 2006 MIT SLOAN MANAGEMENT REVIEW 77

Expertse in one value chain may be a source of advantage in another. For example, UPS has evolved from providing transportation services to offering a range of value-added, logistics-intensive services.

panies may begin to act in a similar fashion and provide compet-

itive components or services.

Integrating Value Breaking free of linear mind-sets helps companies

see opportunities to create value for customers by participating

more actively in new value chains. The telecom industry provides

an excellent example. Landline telephone services and mobile net-

works historically have been viewed as separate enterprises, leading

large telecom operators like AT&T Inc. and BT to spin off their

mobile components into independent companies. However, as

more consumers are abandoning their landlines in favor of mobile

service, fixed-line operators are coming up with novel ways to inte-

grate value with other value chains. As a first step, the companies

are integrating the value of landline and mobile services by linking

voice communications across data and voice networks. (See “Inte-

grating Value in the Telecom Sector” p. 76.)

Creating New Value Propositions Horizontal thinking allows com-

panies to create value propositions that would be impossible with

a traditional linear view. For example, airlines and hotels want to

be able to distinguish price-sensitive budget travelers seeking a

last-minute deal from business travelers looking for convenience

and comfort. Which customers are willing to pay a premium to

stay in a specific hotel, and which would be happy with any

accommodation? Priceline.com Inc. and Hotwire.com (owned by

Expedia Inc.) allow customers to choose travel dates and destina-

tions, but the airline carriers and hotels are not identified until

the flight or room has been paid for. Thus, large airlines and hotel

chains are able to identify bargain hunters without undermining

their pricing structure for customers who value them. By span-

ning value chains within an industry, these companies create a

service that generates new value for companies in each chain.

Although Priceline.com started out by spanning value chains

within the airline industry, the travel reservations industry has

evolved into the sale of integrated (and discounted) hotel, airline

and car-rental packages. This is based on a strategy of spanning

the value chains of multiple industries. Companies like Cendant

Corp., which owns Orbitz, make money on bundling packages

from their own car-rental and hotel chains (Avis, Budget, Days

Inn, Ramada Inn, etc.) with airline tickets. By integrating the

value chains from these industries, they can offer package and

price combinations that would not be possible within a single

value chain. They also foil the efforts of companies looking to

gain market share in electronic price gathering and comparison

across distribution channels, such as Yahoo! Inc.’s FareChase.

Expedia Inc., Travelocity.com LP and other companies have used

similar strategies, often through agreements rather than direct

ownership of hotel, airline or car-rental agencies.

The resulting rapid proliferation of potential sales channels

has created new opportunities for eking value from crossing mul-

tiple value chains. Cendant, for example, is trying to leverage its

software development to provide turnkey software solutions for

inventory and rate management to hotel chains.

Exploiting Value Chains Across Tiers In addition to the value grid’s horizontal and vertical dimensions,

further opportunities for increasing control over inputs and cus-

tomers can be found by exploring the grid in an integrative fashion.

This includes exploring means of controlling the supply of critical

components and uncovering new ways of boosting customer

demand by looking upstream and downstream in other value

chains. Two strategies that take advantage of this diagonal, integra-

tive approach are pinch-point mapping (which involves identifying

potential bottlenecks and threats) and demand enabling.

Pursuing Pinch-Point Mapping In theory, at least, most companies

recognize the importance of knowing which suppliers produce

the key upstream inputs for their products. For example, auto-

motive companies that produce diesel engines rely heavily on a

ceramic particulate filter that is supplied by only two companies

in the world: Ibiden Co. Ltd., headquartered in Ogaki, Japan, and

NGK Insulators Ltd., headquartered in Nagoya, Japan.

When Ibiden experienced quality problems in early 2005,

Ford Motor Co. and PSA Peugeot Citroen were unable to pro-

duce thousands of vehicles. To avoid such problems, it makes

sense for companies to monitor key component supplies and

negotiate alternative sources of components that, if unavailable,

could shut down significant parts of the operation.

Arranging alternative sourcing within one industry is rela-

78 MIT SLOAN MANAGEMENT REVIEW SUMMER 2006

tively straightforward, but it is more complex when the compo-

nents are used across different industry sectors. Pinch points that

span different industries are particularly tricky to monitor

because it is difficult to anticipate demand or use for a compo-

nent or service in another industry. Companies should pay spe- cial attention to components that take time to come on stream

and where the producer can allocate capacity across a variety of

applications. For example, producers of memory chips have reor- ganized production to meet the dramatic increase in demand for

flash memory for camera cell phones, digital cameras and per-

sonal music players; in the process, the supply of other types of memory chips has dwindled, posing threats to computer man-

ufacturers and other companies that rely on those chips.

Companies that fail to follow and manage pinch points can run into serious problems. For example, a fire at a key Philips

semiconductor factory in 2000 caused a worldwide shortage of

the radio frequency chips used by both Nokia and Ericsson. Nokia immediately lined up another source and redesigned other

chips so they could be produced elsewhere. However, Ericsson responded more slowly and lost an estimated $400 million in

mobile phone handset sales. By acting quickly, Nokia was able to

gain a stronger position in the handset market, at least for a time.

History shows that such advantages can be short-lived.

Recently, for example, Nokia failed to monitor developments in

the market for color screens. Because producers of the film-trans-

fer screens were already committed to supplying makers of com-

puter monitors and television displays, Nokia was caught short. This enabled Samsung Group, which produces its own screens, to

achieve significant gains in the market: Samsung’s global market

share in 2004 surged from 4% to 14%, while Nokia’s share

dropped by 2%.

In addition to helping companies avoid supply problems, mon-

itoring other value chains can help them identify potential rivals.

This is evident in the video games industry. As video game players

seek high-end graphics processors, wireless and wired Internet

capabilities, Windows XP and full multimedia drives, consoles like

the Xbox 360 and PlayStation are becoming well suited to audio-

video management. Indeed, the consoles could serve as hubs for

home entertainment, displacing traditional audio-video devices

(MP3, CD and DVD players) and perhaps becoming gateways for

audiovisual entertainment sales in their own right.

Defining Demand Enablers Examining value chains in other indus-

tries can reveal new opportunities to leverage key competitive advantages. Companies that have a particular expertise in a given

value chain may find that that source of advantage is also relevant

in other value chains. For example, United Parcel Service of

America Inc. has evolved from providing transportation services

to offering corporate clients a range of value-added services that are logistics intensive. One such client is Toshiba Corp. UPS man-

Conferen 0 M.Set 272,20 IT Cari,iu

2006 Speakers Include:

Jeffrey P. Bezos Founder and, CEO, Amazoo.’c” i

Rqger McNamee Co-Founder and ….Ma naging Director,Ellev’ation Partners Jonathan F. Miller

Chimnand CEO A/)OL

Phillip A. Sharp Nobel Laurldate; p’rofessor, MITJ Pioneer of RNA Intererence

Padmaýre Warr!or Chief Technblogy! Officern

°otorola

SUMMER 2006 MIT SLOAN MANAGEMENT REVIEW 79

ages Toshiba’s laptop computer service business, which includes

overseeing the availability of parts, transporting broken equip-

ment to a service center, repairing the equipment and expediting it back to the customer. By bundling repair with logistics, UPS can provide a cost-effective solution, within a time frame that is half what Toshiba could otherwise offer.

By reaching outside their established value chains, companies

can create new threats. In entering the computer repair business, for example, UPS poses a new threat to companies such as Unisys

Corp. that have played an important role in this market.

Companies often can find new opportunities to leverage other value chains to enhance the appeal of products that originate within their own chain. Such was the case with Apple Computer

Inc., which in 2002 negotiated an unprecedented agreement with major and independent music labels to sell music over the Web. Most music labels had tried to launch similar ventures but had been unsuccessful, in part because their musical selection was limited and prices were high. Apple went with low prices in hopes of locking users into its iPod music players. The company now has the opportunity to develop new products that use its propri- etary software and designs. Apple drew on the music industry as

a demand enabler for its hardware, and currently it is looking to video and other content services to further lock in that demand.

Life Within the Grid Shifting from a value chain focus to a grid focus requires man- agers to rethink the organization’s value proposition and associ- ated structures from three perspectives: the impact on existing operations; innovations outside of existing operational spheres; and dynamic shifts in the value grid landscape. At the operational level, a company uses the value-grid to leverage information that directly benefits its existing operations.

Understanding the anatomy of purchasing decisions, for example, empowers a company to adjust its provision of services or products to more accurately match customer needs. This directly benefits existing operations and thus ensures minimal

resistance because it does not threaten existing modes of think- ing and operating. With a deep understanding of what drives a purchasing decision, a company can make better decisions about

ways to shift control over the demand and manage risk. Starting from an operational standpoint also makes sense for

pinch-point mapping because tracking and manipulating pinch

points ensures an uninterrupted flow of critical components and services. Further, companies can leverage their understanding strategically to lock out competitors.

Operating with a grid perspective also makes it easier for com- panies to explore innovative strategies that do not directly benefit operations, such as demand enablers. Such exploration is best done through new organizational initiatives. It requires a more system-

atic and conscious effort because it lacks a natural operational

champion, such as a purchasing director or operations manager. Value grids are inherently complex and dynamic, enabling a

nearly limitless web of opportunities. Because of this, vigilant monitoring of the value-grid landscape must become an integral part of ongoing corporate decision-making processes. This includes both identifying new opportunities as well as monitor- ing emerging dangers from other players in the value grid. Some

early warning signs of shifting opportunities and potential threats are straightforward, such as the simplification or stan- dardization of information, which often comes with the decision

to modularize a product or service. But many more opportuni- ties and challenges are idiosyncratic and far more difficult to identify. Thus, on a dynamic level, companies must continually

explore, evaluate and map the broad competitive landscape, rethinking the value grid in terms of their critical activities.

REFERENCES

1. Jay W. Forrester provided one of the first systematic explorations of the complex dynamics underlying information and material flow in multiechelon systems; see J.W. Forrester, “Industrial Dynamics” (Cam- bridge, Massachusetts: MIT Press, 1961). It set the stage for exploring the linkages across parts of the value chain from an operations stand- point. Among other things, it provided an early look at the root cause for dynamic distortions in value chains, which was later expanded and relabeled as the bullwhip effect; see, for example, H.L. Lee, V. Pad- manabhan and S. Whang, “The Bullwhip Effect in Supply Chains,” Sloan Management Review 38, no. 3 (spring 1997): 93-102. Since then, value chain dynamics have become widely explored, as researchers try to understand value creation and the sources of value. The “value chain” concept gained prominence in the mid-1980s as researchers looked for cost optimization and new sources for competi- tive advantage; see J.B. Houlihan, “International Supply Chain Man- agement,” International Journal of Physical Distribution and Materials Management 15, no. 1 (1985): 22-38; and M.E. Porter, “Competitive Advantage: Creating and Sustaining Superior Performance” (New York: The Free Press, 1985). The efforts to understand value chains’ dynamics as a source of core competence and competitive advantage continue to this day. A key concern in our previous research has been, from an operations standpoint, how holistic value chain strate- gies can be leveraged to enhance responsiveness to customer needs; see M. Holweg and F.K. Pil, “Successful Build-to-Order Strategies Start With the Customer,” MIT Sloan Management Review 43, no. 1 (fall 2001): 74-83; and M. Holweg and F.K. Pil, “The Second Century: Reconnecting Customer and Value Chain Through Build-to-Order” (Cambridge, Massachusetts: MIT Press, 2004).

2. Martin Christopher observed that competition increasingly occurs between entire value chains, not individual companies; see M. Christo- pher, “Logistics and Supply Chain Management” (London: Pitman Publishing, 1992).

3. An approach that was developed jointly with Audi AG and Daimler- Chrysler Corp., currently under pilot testing. For a more general dis- cussion on the advantage of small-scale operations in the value chain, see F.K. Pil and M. Holweg, “Exploring Scale: The Advantages of Thinking Small,” MIT Sloan Management Review 44, no. 2 (winter 2003): 33-39.

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