Concept
A concept close to the supply chain is the value chain. The value chain is the series of steps or links in the process that leads to customer satisfaction. If one analyzes the value chain for the profit and loss structures in each link, one can avoid the meta-thinking that goes along with vertical integration. In vertical integration, the thinking goes, “If we own all the steps in our value chain, we can control our costs and supplies better.” That may or may not be the case and a value chain analysis addresses that issue.
A value chain analysis consists of identifying all of the steps involved from raw materials to maintenance. Then, one analyzes each step or link in the chain to determine the profit margins evident in those links. Each link represents a business, perhaps an industry, with all the issues identified in Porter’s Five Forces already introduced. Some links are likely to approach the razor-thin margins of commodities, while other links might have larger margins based on any number of factors from technology to shipping to scarcity. Thus, a wiser supply chain management philosophy would be to assess the potential profit margins in each link of the value chain and then to decide to integrate backward or forward only into those links where the margins and the future expectation of margins were high leaving the thin margin links to others—who then become your suppliers.
Recognizing this link between industries, Porter identified a generic value chain that most manufacturers face and must deal with.6
Example
Henry Ford famously was enamored with the vertical integration concept and organized the Ford Motor Company so that they owned every step in the process to manufacturing an automobile. He went all the way to mining the ore, smelting it into iron and steel, then machining the parts, and creating a highly efficient assembly line that at one point could produce a new Ford automobile every 30 seconds: 3,000 cars a day! This required understanding each of the steps or processes involved in making an automobile; there were 84 steps in making Ford’s most successful model, the Model T. The Model T cost $825 (about $20,000 in 2015) in 1908, but given the efficiencies found through the concept of a moving assembly line, the price had dropped to $260 (about $6,300 in 2015) by 1915. Ford’s River Rouge and Highland Park plants were enormous flagships of a vertically integrated manufacturing system that produced some 15,000,000 Model T’s. At one point, Ford was selling nearly half of all the cars sold in the United States.
Diagram
Source: Adapted from Porter, M. 1985. Competitive Advantage 46. New York, NY: Free Press.
1. Draw the value chain for your organization. Check your diagram with a couple of colleagues to ensure that you haven’t left out anything.
2. Find estimates for the profit margins in each link in that value chain. (Generally, the average profit margin for the industry or the average of the profits of all major competitors in that industry.)
3. Given that (relatively superficial) analysis, which links should management consider integrating into and which links should management avoid entering?
6 https://amazon.com/Competitive-Advantage-Creating-Sustaining-Performance/dp/0684841460