Building a Road Map for the Analysis of Value Chains

Building a Road Map for the Analysis of

Value Chains

Case study in the Northern Netherlands

University of Groningen

Faculty of Economics and Business

MSc Business Administration Strategy & Innovation

Building a Road Map for the Analysis of

Value Chains

Case study in the Northern Netherlands

University of Groningen

Faculty of Economics and Business

Master Thesis

MSc Business Administration Specialization Strategy & Innovation

Author: Lara Bolhuis

Student number: 1564048

E-mail: l.l.bolhuis@student.rug.nl

Date: 14 August 2011

1st Supervisor dr. R.A. van der Eijk

2nd Supervisor dr. K.J. McCarthy

Supervisor L. Zwiers

Preface

After a journey of several months of hard work I can present to you my thesis on building a road map for the analysis of value chains. When I started my orientation on the topic for VNO-NCW Noord in 2010 I could not yet expect the road that had to be travelled to write this report. Although the process of the research was longer and more difficult than anticipated at first, with some small bumps in the road, it was a very interesting and instructive experience for me. Although it took some time to find the right direction and an appropriate research question for the study, it has been great to get the opportunity to combine an academic thesis with the practical setting of an organisation that operates in the region in which I grew up and studied.

Not only did VNO-NCW Noord provide me with an interesting and relevant topic for my thesis, but I was also offered a motivating and fascinating environment to start the research. Help was offered when needed and I was allowed to learn more about all the activities of the organisation. Therefore I would like to thank the whole staff for the pleasant times that I had there. I especially express my gratitude to Lambert Zwiers for the motivating meetings in which he gave me great advice. Also the university offered guidance for the academic aspects of the research during the whole process, for which I thank my supervisor Rene van der Eijk. In addition, I am very grateful to all interviewees for participating.

However, I cannot conclude without thanking my dear parents and my sister Annika for their unconditional support, not only while I was writing my thesis, but during my whole studies. Last but not least I thank my friends, and especially Jorg, who have been a wonderful part of my (student) life and provided great motivation or distraction when needed.

Abstract

The goal of this study is to develop a method for analysing value chains on a regional level to provide insight in the functioning and strength of a value chain. This method should not be too time consuming and should not require confidential management accounting information. The results of this analysis could be a starting point for organisations to improve the position of a specific chain. Although there are numerous initiatives to support regions or industries, the application of value chain theory is very limited.

The method that is developed is a six step road map, which includes interviews that are based on findings in literature. A case study is performed to illustrate the use of the road map and to test its applicability in practice. The case study shows that following the road map provides a clear picture of the analysed chain and identifies points of interest. In addition the interviews indicated that most entrepreneurs think that using value chain theory more in the conduct of business could have great benefits for the position of a chain.

Executive Summary

A relatively new approach of handling regional relationships is seeing them in the context of vertical cooperation in value chains. A value chain can be defined as ‘the collection of organisations that are working together to bring a product or service to the market, from raw material to final consumption, by adding value to it. This includes primary activities that are directly connected to the creation, sale and after-sale assistance of the product or service, and those activities that are not directly connected, but support these activities and deliver critical input’.

The goal of this research is to provide VNO-NCW Noord with clear insights in value chain theory and to offer a tool to analyse value chains in a qualitative and exploratory manner. This analysis should lead to understanding the functioning and strength of chains. The functioning of a chain includes, amongst other things, the relationships between the different links and the organisation of the coordination within the chain. Strength on the other hand covers the position of a chain compared to its environment and competing chains. The method should only take relatively little time to execute, without the need for detailed, often undisclosed, (accounting) data.

A road map for executing value chain analysis is built based on literature. This road map entails six basic steps and is complemented with a questionnaire. The first step is defining the primary area of research interest, followed by determining a point of entry for the analysis in step two. The third step is setting up a map of the value chain. Depending on the analysis this step can be repeated during the collection of data and at the end to complete the map. Elements, variables and measures have to be selected for the analysis in the fourth step, based on the research question that is formulated. The fifth step is collecting data, after which the final sixth step takes place. Step six includes assessing the collected data, reporting on the outcomes and drawing conclusions to answer the research question. It can be necessary to re-evaluate the map until the analysis is completed. The value chain can be mapped in a tree, including the primary activities and the important support activities. With colour, arrows, different block sizes and other graphics the layout of the map can add extra information about the chain too.

both can be the driving force of the chain, which gives more information on the type of the chain. An important topic in assessing the functioning of a chain is governance. This covers the rule making, rule monitoring and the achieving of the rules, but also the sanctions for complying or not complying with these rules. The level of trust is another indicator of the functioning, as is the distribution of rents. Identifying the scale of production and sales indicates on what level the analysis should take place. Although these indicators have only been quantified with the use of a five-point scale during the interviews for the case study, it does provide understanding of the functioning, and it makes comparison of the answers to some degree possible. Determining the strength of a value chain can be done by applying Porters’ Five Forces and Porters’ Diamond. These two models cover a large number of different determinants that provide an extensive overview of the competitive environment and the position of the value chain.

The value chain of steel motor yachts up to 24 meter was selected as the case study to which the road map was applied. It turns out that the value chain concept is not understood equally by everyone. The limited number of interviews makes it difficult to generalise findings and to form a complete picture of all details. However, the questionnaire contains a large number of questions covering a broad selection of topics. This makes it possible to already gain a lot of insight in the value chain and its overall functioning and strength. The topics that are included in the road map turn out to be relevant in analysing value chains relatively quickly without the need for confidential data.

The results of the analysis are for a large part dependent of the respondents that are selected for the interviews. Interviewing is, next to desk research, the most important method to collect data. Although it is unlikely that all details of a value chain are revealed, possible points of interest for further research or a direction for policy attention can be pointed out. With these insights, businesses or other organisations that want to support a chain, can take steps for improvement. Examples could be lobbying at the government for better supporting conditions, or bringing links together that are not yet cooperating enough. An optimally organised chain is expected to benefit the final product, the competitive position of the chain and therefore eventually the links in the chain too.

Table of Content

2.1 Development of Value Chain Theory 7

2.1.1 Introduction of the Value Chain 7

2.1.2 The Context and Boundaries of Value Chains 10

2.2 Analysis of Value Chains 12

2.2.1 Introduction into Value Chain Analysis 12

2.2.2 Elements of Value Chain Analysis 14

2.2.2.1 Scale of Value Chain Analysis 15

2.2.2.2 Productive Actors 15

2.2.3 Steps in Undertaking Value Chain Research 16

2.2.3.1 The Point of Entry 16

2.2.3.2 Mapping Value Chains 17

2.2.3.3 Elements and Variables 18

2.3 The Functioning of Value Chains 19

2.3.1 Governance 19

2.3.2 Types of Value Chains 22

2.3.3 Rents 22

2.4 The Strength of Value Chains 24

2.4.1 Introduction in Competitiveness 24 2.4.2 Competitiveness of Sectors 24 2.4.3 Competitiveness of Regions 26 2.5 Increasing Performance 28 2.5.1 Management Accounting 29 2.5.2 Benchmarking 31

2.5.3 Upgrading and Innovation 31

2.5.4 Value Chain Responsibility 32

2.6 Summary 33

3 Research Methodology and Data Analysis 34

3.1 Research Design 34

3.2 Data-Collection and Analysis 35

4 Road Map to Analysing Value Chains 39

4.1 Introduction of the Road Map 39

4.2 General Road Map to Analysing Value Chains 40

4.3 Specific Road Map to Analysing Value Chains 43

4.4 Displaying Outcomes 45

4.5 Summary 47

5 Application of the Road Map to a Case 48

5.1 Introduction of the Region and Case 48

5.2 Case Study: Yacht Industry 49

5.2.1 Introduction 49 5.2.2 Value Chain 50 5.2.3 Functioning 51 5.2.4 Strength 54 5.2.5 General Picture 58 5.3 Summary 60

6 Discussion and Conclusion 61

6.1 Discussion of Findings 61

6.2 Conclusion 63

6.3 Managerial Implications and Recommendations 64

6.4 Recommendations for Further Research and Limitations 65

1 Introduction

1.1 Introduction

One of the central concerns of governments and industries has become competitiveness. However, firms and not nations are the ones competing in markets (Porter, 1990). There are many initiatives and organisations that have set themselves the goal of supporting the competitiveness of a region. This also applies to the Northern Netherlands, which includes the provinces of Groningen, Friesland and Drenthe. It is the least densely populated region of the Netherlands with about 1,7 million inhabitants1. Although the region covers approximately 25 per cent of the country, only 10 per cent of the population lives in these three provinces. Looking at data provided by the CBS (Statistics Netherlands), it shows that the northern region has ranked below the national average economically over the last years. The unemployment rate has been much higher2_{, and the economic growth rate is}

lower on average3 (www.cbs.nl). In addition, in the report of Broersma and Van Dijk (2006) is stated that the general growth labour productivity in the northern three provinces is lower than nationally. Nevertheless, the differences have been decreasing in general lately.

Despite the difference in the rate of economic development with the rest of the country, the Northern Netherlands profiles itself as a region with many opportunities. Over the last years these opportunities have even grown due to investments. The three provinces are cooperating increasingly to improve their competitive position on a national and international level, especially since the founding of the SNN (Samenwerkingsverband Noord-Nederland, the Northern Netherlands Provinces) in 1992 (SNN, 2007). This governmental organisation is a joint agreement between Groningen, Friesland and Drenthe and a framework for co-operation to strengthen the spatial planning and economic structure of the Northern Netherlands. There are also initiatives to join the three provinces into one northern province to improve its position even more (Dagblad van het Noorden, 2009; DvhN, 2010). In addition to the founding of SNN, a large number of other initiatives, organisations and programs have been set up over the last years to seize the opportunities in the region and to support its competitiveness.

The co-operation of the provinces can be successful in strengthening the position of the Northern Netherlands. However, this will probably not be enough to catch up with the national level. An increase in labour productivity, and the economic situation, asks for innovation, which could be based on technological or social renewal, or tapping into new markets. This asks for creativity, since entrepreneurs will have to look for ‘Neue Kombinationen’ (new combinations) as described by Schumpeter (Broersma and Van Dijk, 2006). These new combinations are what innovation is about, according to Schumpeter. They disturb the equilibrium of the economic system. However, they will not just occur, but have a basis in the pre-existing economic structure (Hospers, 2005). Broersma and Van Dijk state that this is possible in the Northern Netherlands if entrepreneurs and employees have an open attitude towards new developments, for which many factors are important. One of those is managing relationships with other companies, inside and outside of the own sector.

A relatively new approach of handling regional relationships is seeing them in the context of vertical cooperation in value chains (Kaplinsky and Morris, 2001). A new approach like this can also be seen as an innovation in itself. A value chain can be defined as ‘a network of businesses working together to bring a product or service to the market’ (Wienclaw, 2008a). It describes the steps a good or a service goes through from raw material to final consumption (Johnston and Lawrence, 1988), and focuses on these steps in terms of value that is added to the product or service. As described later on in this research, working together with other companies in the value chain instead of seeing them solely as competitors, could bring great benefits.

According to data from the CBS, in 2007 the value added in the Northern Netherlands was 9,8 per cent of the total added value nationally. Which is less than expected, considering 10,4 per cent of all Dutch inhabitants lived in the northern region at that time. It is only a small difference, but the growth in value added has lagged behind the national level in general over the last 15 years4 (www.cbs.nl). A change in attitude towards the value chain might result in an increase of the total amount of value added, leading to an improvement of the economic position of the Northern Netherlands compared to other regions.

1.2 Problem Definition

1.2.1 Problem Introduction

The concept value chain was introduced in 1985 by Michael Porter. Acknowledging that this concept can not only be important for single firms, but also for a region, it is applied in this thesis to research how chains in a region can be analysed. Since Porter there have been many authors that referred to the value chain. However, in the strategies and initiatives that are set up to improve the competitiveness of the northern region (e.g. by SNN5 and NOM6), there is no evident attention for this approach.

One organisation that has become interested in the concept value chain, and the possible benefits it could bring to the Northern Netherlands, is VNO-NCW Noord. VNO-NCW Noord is an employers’ organisation that represents the interests of Dutch businesses in the northern region, and works together with employers’ organisations from other regions and nationally. They organise events, provide support on different levels, and lobby for their members. Through their activities, the organisation strives amongst other things for the improvement of the external environment for businesses and entrepreneurs7. Paying more attention to value chain theory in their activities might be a possibility for them to support the competitiveness of the Northern Netherlands.

1.2.2 Research Goal

Before formulating the research question of this thesis, the management problem and the goal of this research are described. VNO-NCW Noord is considered to be an important player in the northern region, with the goal to lobby for its members towards government and politicians and to support and improve the interchange of knowledge and experiences. The organisation wants to gain insight into value chain theory. It wants to know how to determine the functioning and the strength of a chain, and how this knowledge can be applied in the Northern Netherlands. The functioning of a chain includes amongst other things the relationships between the different links and the organisation of the coordination within the chain. Strength on the other hand covers the position of a chain compared to its environment and competing chains, and includes looking at the weaknesses too. This management problem is translated into a research question and multiple sub-questions, as this amongst other things requires a definition of a value chain and a method of analysing it. These questions are stated in the next section.

www.snn.eu

6

The goal of this research is to provide VNO-NCW Noord with clear insights in value chain theory and to offer a tool to analyse value chains in a qualitative and exploratory manner. This analysis should lead to understanding the functioning and strength of chains, but the method should only take relatively little time to be carried out, without the need for detailed, often undisclosed, (accounting) data. The research adds to existing literature by combining previous findings into a new method suited for this approach.

Based on the outcome of the research VNO-NCW Noord plans to organise meetings for the important players of a value chain for two reasons. The first aim of these meetings is to create awareness by showing that the players are part of a value chain. This is followed by offering tools to improve the competitiveness of the chain, and therefore the position of the different parts of the chain. Secondly, based on analysis of important value chains in the region, insight can be gained by VNO-NCW Noord in the functioning of the external environment of the chain and in what way it can be improved.

In order to provide an answer for this research problem, theory has to be translated into a practical approach. This means simplifying outcomes from the literature review into something that can be applied by VNO-NCW Noord and the organisations represented by its members.

1.2.3 Research Question

Based on the management problem and the research problem described above the following research question is formulated: How can value chain theory be applied to analyse the functioning and strength of value chains?

In order to answer this question, four sub-questions are stated that look at different aspects that are important for this research.

1) What is the definition of the concept ‘value chain’? 2) How can a value chain be analysed?

By answering these questions, theory is translated into a practical approach that can be applied by organisations as VNO-NCW Noord or firms. Based on the findings VNO-NCW Noord can decide on their strategy concerning specific value chains and the possibilities to support an increase in their competitiveness.

1.3 Research Outline

In this thesis the theory of value chains is researched, and the findings in theory are translated in such a way that it can be applied in practice. The next part, chapter 2, of this research concerns a literature review. First a definition of the concept value chain is provided and the background of this theory is shortly discussed. Also the characteristics of value chains are described in this chapter. In addition, a close look is given at the aspects that influence the functioning and strength of a value chain. The methodology and data analysis are discussed in chapter 3, showing how the research is executed and how data was collected and analysed. Based on the findings in literature a road map to undertaking value chain analysis is formed, this road map is described in chapter 4.

As the goal of this research is to apply the outcomes in practice, a case study was held which shows how VNO-NCW Noord (or other organisations) could do this. This case study illustrates how to use the proposed road map and provides an opportunity to test it too. Before the outcomes of the case study are described in chapter 5, the Northern Netherlands are shortly introduced to provide understanding of the region in value chain analysis. This leads to a discussion of the findings and the conclusion in chapter 6. The findings are expected to lead to implications for the strategy of VNO-NCW Noord concerning this topic.

Since the economic situation is continuously changing, applying the outcome of this research on a region is likely to be applicable only in the near future. As Schumpeter stated, the equilibrium of the economic system will be disturbed by shocks through new combinations (Hospers, 2005), and one of these shocks could influence the situation on which this research is based.

2 Literature Review

2.1 Development of Value Chain Theory

In the process of developing a method for value chain research on a regional level it is helpful to discuss the development of value chain theory. Below the introduction of the value chain theory and an overview of related concepts are described. Additionally the context in which this concept exists is indicated, as are the boundaries that should be taken into account when performing an analysis of value chains.

2.1.1 Introduction of the Value Chain

According to Kaplinsky (2004) a concept similar to the value chain was first used in the 1960’s and the 1970’s by analysts that charted a path of development for mineral-exporting economies. In French literature it was adopted too in the form of ‘filière’, which can be translated as thread, describing the flow of physical inputs and services in the production of a final product (Kaplinsky and Morris, 2001). In 1985 Michael E. Porter explains his theory on the value chain in his book Competitive Advantage: Creating and Sustaining Superior Performance. He described a firm as a collection of activities that are performed to design, produce, market, deliver, and support its product. In figure 2.1 is shown how these activities can be represented using a value chain. According to Porter, the activities a firm performs in a particular industry form the relevant level for constructing a value chain. Analysing the chain makes it possible to identify the sources of competitive advantage and can influence competitive strategy, as it increases understanding of the behaviour of costs and the potential sources of differentiation.

describes vertical linkages, which are the linkages with value chains of suppliers and channels, and linkages with buyers’ value chains.

Figure 2.1: The Generic Value Chain (Porter, 1985; p37)

Also in his book The Competitive Advantage of Nations (1990) Porter refers to the importance of value chains for firms in global industries, and describes the ‘value system’. This consists of the collection of value chains of suppliers, the firm, channels and buyers (figure 2.2). Porter indicates that linkages are important for national competitive advantages as well, with important roles for demand conditions and vertical relationships among industries to stimulate competitive advantage (p287).

Figure 2.2: The Value System (Porter, 1990; p43)

These networks do not only fulfil market needs, but also anticipate the changes of customers and environments and respond accordingly to win the competitive battle.

The same idea is described by Johnston and Lawrence (1988). They looked at the ‘value added chain’, and described the Value-Adding Partnership (VAP) as an organisational form that competes with large vertically integrated companies. Most of these integrated companies only emphasise one competitive dimension, and this focus, which goes for horizontally integrated firms as well, forms a liability. A VAP makes it possible to have a focus in every step of the value chain, and still have a common goal. This organisational form can be classified as a network within the models of coordination (Thompson et al., 1991).

Gupta and Subramanian (2008) approach the value chain concept from a vertical view as well. They state that the modularization and global configuration of the value chain is creating new regional clusters. However, they indicate that global spreading of the value chain is challenging the sustainability of the value generated within traditional regional clusters, where value chains in several inter-connected sectors were historically located and nurtured. Outsourcing could be an option when, as described by Porter (1985), channels can substitute certain activities of a firm. However, a risk for regional value chains concerning outsourcing relates to outsourcing to other nations, instead of within the own regional cluster (Gupta and Subramanian, 2008). This is a threat to local regional clusters, leaving a hole by moving part of the value chain to another place. Mol, Wijnberg and Carroll (2005) use the single value system of Porter too as a basis to create a vertical setting of a value system to research the occurrence and viability of vertical integration and new entry.

According to Womack and Jones (1996) value can only be defined by the ultimate customer. In their book Lean Thinking a way to prevent waste, an activity which absorbs resources but creates no value, is described. This method, called lean thinking, provides:

In order to implement lean thinking the value stream should be identified. This value stream is somewhat comparable with the value chain described by Porter, as it is the set of all the specific actions required to bring a specific product through the three critical management tasks of any business. These tasks are the problem-solving task, information management task and the physical transformation task, and refer to activities that are “required to design, order, and provide a specific product, from concept to launch, order to delivery, and raw materials into the hands of the customers” (Womack and Jones, 1996; p311). The goal of lean thinking is to reach perfection, the stage in which all waste has been eliminated and all activities along a value stream create value. Translating this to the value chain and value system described earlier, this would mean that in order to eliminate all waste, relationships and linkages should be used optimally. They should not be seen as a zero sum game in which one gains at the expense of the other, but as a way in which both can gain (Porter, 1985).

2.1.2 The Context and Boundaries of Value Chains

The description above of the development of value chain theory and the overview of how it has been employed in literature provides a basic understanding of the central concept in this research. However, more attention for distinguishing value chains with other ‘chains’ and related concepts is needed. Especially the terms supply chain and value chain are sometimes used interchangeable in literature (e.g. by Sturgeon, 2001). Wienclaw (2008b) has provided definitions of both terms. Supply chain refers to a network of organisations involved in production, delivery, and sale of a product. Each organisation in the network provides an activity that adds value to the product or service. The supply chain includes the flow of tangible goods and materials, funds and information between the organisations in the network. A value chain is a network of businesses working together to bring a product or service to the market, typically comprising one or a few of primary suppliers, supported by many secondary suppliers. Each of these suppliers adds value to the product or service before it is offered to the customer. Sometimes recycling is even included in the value chain (e.g. Kaplinsky and Morris, 2001; p5).

… a “chain” maps the vertical sequence of events leading to the delivery, consumption, and maintenance of goods and services—recognizing that various value chains often share common economic actors and are dynamic in that they are reused and reconfigured on an on-going basis—while a “network” highlights the nature and extent of the inter-firm relationships that bind sets of firms into larger economic groups (Sturgeon, 2001; p9).

As described above Porter applied the value chain concept to a single firm. However, in modern value chain analysis mostly the extended (vertical) value chain is meant when using the concept value chain (Kaplinksy and Morris, 2001), which Porter referred to as the value system (1985, 1990) and Womack and Jones (1996) called a ‘value stream’. This vertical approach will be applied in this research too.

In order to execute effective value chain analysis the participation of different disciplines is required, since value chain inquiry spans different economic branches and sectors. As it covers a range of interconnected economic activities, and thus provides the potential for coordinating what might be termed joined-up policies between different arms of government (Kaplinsky, 2004). Taking this into account it is also useful to define the concept of clusters, as this is often a focus point in present (regional) policies (e.g. of SNN). Porter (1998) defines clusters as ‘geographic concentrations of interconnected companies and institutions in a particular field’ (p78). This includes the entities that are important in competition, as for instance providers of suppliers of specialised infrastructure, suppliers of specialised inputs, and governmental and other institutions providing amongst other things education, information and research. However, it does not mean that these are all involved in the process of bringing a product or service to the market.

Looking at what has been provided by literature, the following definition of a value chain can be formulated: A value chain describes the collection of organisations that are working together to bring a product or service to the market, from raw material to final consumption, by adding value to it. This includes primary activities that are directly connected to the creation, sale and after-sale assistance of the product or service, and those activities that are not directly connected, but support these activities and deliver critical input.

not. This problem can also occur in describing a value chain. In the definition of the value chain above it is stated that it concerns ‘the network of businesses that work together to bring a product or service to the market […] by adding value to it’. As one probably can imagine, this can lead to a value chain that includes an enormous number of businesses.

2.2 Analysis of Value Chains

There is more than only one way of analysing value chains, and it has been done in different contexts and on several scales. As described in the previous part, researchers have used the concept value chain and related theories in various circumstances. The context in which value chains have mostly been approached over the last years is explained shortly in the following part. In addition, different steps that can be taken in analysing value chain are given. This is followed by an overview of important dimensions that have been described in literature in the rest of the chapter. As it concerns a large pool of theories and dimensions, these findings are categorised in several main themes of value chain analysis in this chapter.

2.2.1 Introduction into Value Chain Analysis

McCormick and Schmitz (2001) describe three dimensions of value chain analysis, starting with its input-output structure. They state that a value chain can be seen as having five different sections: design, inputs, production, wholesale and retail (figure 2.3). These phases can differ depending on the product and the chain that is analysed, however they can be used as a basis to understand the process. In every phase there are supporting services needed, as for instance finance and transport, to keep the process going. Next to the physical input-output structure there is also a flow of knowledge in value chains, which can differ in intensity in the separate phases.

Figure 2.3: Chain of Value Adding Activities (McCormick and Schmitz, 2001; p18)

The second dimension is the geographical spread of the value chain. As their study is specifically on global value chains it is a central aspect in their report, in studies on the functioning of regional value chains this dimension is approached differently due to the scale of the research.

The third dimension focuses on the topic of control in value chain, which is called governance. Gereffi’s findings on power relations refer to this too. Especially this dimension provides information on the functioning of a specific value chain. For that reason a more elaborate discussion on this dimension takes place in the next part of this chapter.

There are more enumerations of important elements in value chain research. In his study on spreading the gains of globalization Kaplinsky (2004) formulated three important components of value chains that form the key elements of value-chain analysis, based on the existence of competition. The first one is that value chains are repositories for rent, and these rents are dynamic. Secondly, effectively functioning value chains involve some degree of ‘governance’. And third, effective value chains arise from systemic-, as opposed to point-efficiency.

analyse it in detail. According to Sturgeon, value chains operate in a complex environment with a variety of critical inputs, shown in figure 2.4.

Figure 2.4: The extended value chain with inputs (Sturgeon, 2001; p11)

Together with other elements of value chain research the above mentioned dimensions and components are explored and explained later in this chapter.

2.2.2 Elements of Value Chain Analysis

2.2.2.1 Scale of Value Chain Analysis

The organisational scale of value chains involves the thickness and length of a chain. As the value chain entails the whole chain of productive activities, the organisational scale of the chain varies depending on the organisational scale of these activities. Looking at the length of a chain, it includes the whole range of activities needed to bring a particular set of products to market (Sturgeon, 2001). In addition to this, there is the geographical spread that requires attention (McCormick and Schmitz, 2001). Sturgeon (2001) refers to the spatial scale, and distinguishes different scales, namely local, domestic, international, regional (in the supra-national sense) and global. When starting an analysis of value chains, one should define the spatial scale in which the research takes place in order to have the appropriate scope.

2.2.2.2 Productive Actors

Productive actors are the different kinds of firms that are participating in production in value chains, a topic in which many different classifications are being used (Sturgeon, 2001). In table 2.1 an overview is delisted, with the most important actors in production that can be used to label productive actors in a chain. Determining a terminology for the different actors in a chain prevents misunderstanding the role of these actors. Most terms will be clear looking at the table, but some additional information is provided on lead firms and turn-key suppliers.

Actor Scope of activity

Integrated firm  Product strategy

 Product definition  Design

 Manufacturing  Sub-assembly

 Component manufacturing  Marketing, sales and distribution

Retailer  Sales

 Marketing

 Value-added packaging and system integration

Lead Firm  Product strategy

 Product definition  Product design  End user sales  End user marketing

Turn-key Supplier  Complex parts and services

 Process R&D

Component Supplier  Discrete elements (component parts and services)

Lead firms usually ‘initiate the flow of new products through the value chain and help to drive the organisation and geography of their production networks by demanding that their suppliers engage in new activities and invest in new places’ (Sturgeon, 2001; p8). A large degree of power is often part of this role, however this does not always have to be the case as also other parties, as for instance retailers or suppliers, can have most power in a chain. To this point has to be added that the scope of value chain activities of a firm are not static, which means that large firms can have different activities without necessarily being an integrated firm. Turn-key suppliers ‘provide a full-range of services without a great deal of input by lead firms’ (Sturgeon, 2001; p9). Although lead firms will probably provide instructions on what should be made, the turn key supplier can decide how and maybe even where this is done.

2.2.3 Steps in Undertaking Value Chain Research

In the previous parts the value that executing value chain analysis can have for firms has already partly been stressed. However, it is not always an easy task to perform (Shank and Govindarajan, 1992). Some dimensions of value chain analysis are already discussed, but a way to perform the analysis is still needed.

Below the basic steps in undertaking value chain research in a simplified and qualitative manner are described. As indicated in the introduction, there is a need for a method that does not require detailed management accounting information and takes relatively little time to execute. Although the resulting analysis might not include insights in all aspects that are part of a value chain, it can improve understanding on what belongs to a specific value chain and how it functions. Yet, as no chain is completely identical to another, each analysis will be unique (Shank and Govindarajan, 1992).

Different methods for analysing value chains for different objectives have been discussed in literature. Although in most studies there is no explicit description of how they identified a specific chain, there were some sources that provide that information (Kaplinsky and Morris, 2001; Shank and Govindarajan, 1992). The appropriate basic steps to perform value analysis have been selected, and are discussed below.

2.2.3.1 The Point of Entry

and Govindarajan, 1992). First the primary area of research interest has to be chosen, deciding what you want to know about a specific chain. After that, another decision has to be made. Since individual firms may feed into a variety of chains, particularly the links in the beginning of the chain, it is difficult to determine what exactly is part of the chain, and what is not. In order to have an idea of what the relevant parts are, a point of entry for value chain analysis is to be determined. Although you can still expand the chain as much as you like, any research will benefit from a clear focus.

Examples of point of entry are retailers, key producers, independent buyers and sub-suppliers. The chosen point of entry will determine which links and activities in the chain are to be the subjects of special inquiry. For example, if the primary area of research interest concerns agricultural producers, the point of entry for this research will be farms (Kaplinsky and Morris, 2001).

2.2.3.2 Mapping Value Chains

After deciding on the point of entry, an initial map of the value chain can be made. In order to come to a good analysis the chain has to be modelled. However, not all parts can be included here, as reality is too complex to model (figure 2.5). In the process of choosing what parts to map, there are several theories that can be helpful.

Figure 2.5: Value Chain Mapping: Theory and Reality (Kaplinsky and Morris, 2001; p52)

Porter states that ‘the appropriate degree of disaggregation depends on the economics of the activities and purposes for which the value chain is being analysed. […] the basic principle is that activities should be isolated and separated that have different economics, have a high potential impact of differentiation, or represent a significant or growing proportion of cost’ (1985, p45). In addition, Porter makes a distinction between primary and support activities. Although in his definition of value chain the focus was only within a firm, this distinction can be applied to the ‘vertical value chain’ as well. This can also be done by making a distinction by putting different weights on enabling industries (Feser and Isserman, 2009).

Another theory to apply is based on dividing the value chain into different stages based on the fact whether a separate market exists (Shank and Govindarajan, 1992). These are called the key building blocks of a chain, the so-called ‘value chain stages’. The difficulty is to make sure that small or supporting, but strategically important, building blocks are not ignored. For the last addition on how to map a value chain, we return to the organisational scale discussion of Sturgeon (2001). He states that the lead firm should be the central focus in this map and the analysis that follows, as this firm initiates the flow of resources and information. However, as final markets are increasingly the driver in many value chains it is important to understand the nature of these markets too (Kaplinsky and Morris, 2001).

2.2.3.3 Elements and Variables

After the value chain is mapped, elements and variables have to be selected that can be used to answer the research question(s). Depending on the research question asked, different elements or variables (quantitative or qualitative) can be identified (Kaplinsky and Morris, 2001).

We can now return to the research question formulated in the introduction, namely how value chain theory can be applied to analyse value chains in a region, and more specifically, how to analyse the functioning and the strength of a chain. In order to answer the second part of this question insight in the elements that influence the functioning and strength of value chains in a region is needed. This asks for measures that provide indications on how the links of a value chain operate and cooperate and on how strong they are. The following two parts of this chapter provide these. When performing value chain analysis to answer a different research question, they should be adjusted accordingly.

estimate what sources can be used. Some sources are very costly or time consuming and might not be appropriate to use. Kaplinsky and Morris (2001) add that executing primary research through interviews and scored responses with key players can be a solution. Again, the willingness of the respondents is crucial in obtaining most data (Dekker, 2003). After data is collected, the outcomes can be processed and used to answer the research question.

2.3 The Functioning of Value Chains

The first subject on which details are needed in order to answer the research question is the functioning of value chains. The functioning of a value chain includes amongst other things the relationships between the different link and the organisation of the coordination. There are different variables that provide insight in this, namely governance, types of chains and topic of rents.

2.3.1 Governance

One topic often discussed in literature focuses on the topic of control in value chain, namely governance (Kaplinsky and Morris, 2001). The possible varieties of direct and indirect control are endless, as they are the result of human interaction. Four main types of coordination forms are identified: market, balanced network, directed network and hierarchy (McCormick and Schmitz, 2001). In a market firms mainly deal with each other in exchange transactions on an ‘arms-length’. In a balanced network firms do form a network, and prefer to deal with firms within their own network, but there is no one firm or group that has control over the others. In a directed network however, there is a form of control, mostly by lead firms. These firms specify what is to be produced by whom and monitor the performance of the firms. The last form, hierarchy, contains vertically integrated firms that can directly control all or most part of the activities that are performed in the chain. The types are similar to the types of coordination mentioned by Thompson et al. (1991), and it can be concluded that the network-type focuses most on cooperation of firms within the chain in total.

demands of others. The second point concerns the extent of chain power, and how that is linked to the relative size of a particular firm. Often it is the case that the larger the firm, the more influential the role of the firm. Some possible ways to approach at this relative size are looking at the share of chain sales, share of chain value added, control over distinctive competence and key technology or holding the chain market identity through for instance a brand name (Kaplinsky and Morris, 2001). Three forms of governance are distinguished, namely legislative, judicial and executive governance. The first form refers to the basic rules that define the conditions for participation. This can be seen as the rule-making part of the chain. Second, the necessity to audit performance and to check compliance with these rules belongs to judicial governance. This can be described as the rule-monitoring part. The last form covers the assistance that is provided to the different links in the value chain in meeting the operating rules mentioned in the previous forms. An overview of these distinctions in governance, and examples on how they can be exercised is displayed in table 2.2.

Exercised by parties internal to chain Exercised by parties external to chain

Legislative governance

 Setting standards for suppliers in relation to on-time deliveries, frequency of deliveries and quality

 Environmental standards  Child labour standards

Judicial governance

 Monitoring the performance of suppliers in meeting these standards

 Monitoring labour standards (NGOs)  Specialised firms monitoring

conformance to ISO standards

Executive governance

 Supply chain management assisting suppliers to meet these standards  Producer associations assisting

members to meet these standards

 Specialised service providers

 Government industrial policy support

Table 2.2: Examples of value chain governance (Kaplinsky and Morris, 2001; p31)

Types of rule Positive sanctions Negative sanctions External to the chain Legislative requirements - e.g. quality standards Informal rules promoted by civic associations None Promotion of brand Fines; compulsory closure Consumer boycotts; adverse publicity; campaigns Internal to the chain

Rules set by key links in the chain which

producers need to attain Lead-supply arrangements; long-term relationships Delisting as a supplier; swing-supplier status; lower prices due to checking of all incoming materials

Table 2.3: Sanctions and rule keeping (Kaplinsky and Morris, 2001; p73)

The trust that suppliers and customers have in the effectiveness of a governor’s command of a chain reflects the power of its sanctions, the so-called legitimacy of power. Especially in assessing the viability of the chain long-term trust is important. The level of trust (high or low) can be assessed with the help of some data points, as for instance the length of contracts and the determination of prices. An overview on how to assess trust relations in the value chain can be found in table 2.4.

Low trust chains High trust chains

Length of trading relationship Short-term Long-term

Ordering procedure Open bidding for orders, with

prices negotiated and agreed before order commissioned.

Bidding may not take place, or likely winner known in advance. Prices settled after contract.

Inspection Inspection on delivery. Little or no inspection on

delivery for most parts.

Degree of dependence Supplier has many customers,

and customer has multiple sources.

Few customers for supplier and single- or dual-sourcing by customer.

Technical assistance Expertise rarely pooled, and

assistance only when paid for.

Extensive unilateral or bilateral technology transfer over time.

Communication Infrequent and through formal

channels. Narrowly focused on purchasing department.

Multi-channelled, including engineers, personnel department and top management; frequent and often informal.

Price determinations Adversarial, with hiding of

information.

Non-adversarial with “open books”.

Credit extended Punitive or no credit extended. Easy access to letters of credit,

longer payback period, easy terms.

Outsourcing payment terms Long delays in paying agents

and informal economy producers.

Payment on receipt of finished goods.

Although theory defines different areas in which governance occurs in value chains and different sorts, in practice multiple points of governance within a chain are possible and is it likely that different sorts exist next to each other within a single chain (Kaplinsky and Morris, 2001).

2.3.2 Types of Value Chains

Two different types of value chains can be identified. Partly based on the discussion on governance, a distinction can be made between buyer-driven and producer-driven chains. The critical governing role of buyer-driven chains is played by buyers, at the top of the chain. They are characteristic for labour-intensive industries, for instance clothing and furniture. Producer-driven chains on the other hand can be found in industries in which the key-producers, generally commanding vital technologies, coordinate the various links of the chain. These chains are typically capital- and technology intensive, and the producers take responsibility for assisting the efficiency of both their suppliers and their customers (Kaplinsky and Morris, 2001).

Although there are different types of value chains, it is important to notice that although in theory it may seem that the distinctions are clear-cut, this is not per se so in reality. Value chains can be both producer- and buyer-driven in some cases. In addition, multiple points of governance of all forms (legislative, judicial and executive) can be present, at different points in the chain. But it can also be the case that a chain has very little governance at all (Kaplinsky and Morris, 2001).

2.3.3 Rents

Taking advantage of or even constructing barriers to entry helps to protect oneself from competition can lead to sustainable income growth. There are different types of rents that can be identified. Rents constructed by the firm (technology, human resources, organisation and marketing), constructed by the chain (relational), based on resources and rents that accrued from actions external to the chain (government policy, infrastructure and financial). When looking at these rents it is important to remember that they are often dynamic, as barriers are mostly not absolute. Information on these rents can in most cases be collected at firm level, amongst other things, but it requires also a form of comparison as it encompasses access to capabilities that others do not have.

Figure 2.6: The generation and dissipation of entrepreneurial surplus (Kaplinsky and Morris, 2001; p26)

One of the issues concerning rents and barriers is the discussion on distribution. A popular topic in research is the distribution of these rents along the chain, especially when analysing global value chains (Kaplinsky and Morris, 2001). Building a tree of gross output prices, beginning with raw material and ending with the sold final product, is a helpful tool for gaining insight in input-output relationships in the chain. However, in discovering distributional patterns it has only limited value, as it does not indicate where value has been added exactly. This value can be added within a part of a firm or plant, in a firm or plant, a link in the chain, in a specific region or in a country. This discussion is not only relevant in global value chains. In researching a region, it can be researched what value is added in those (parts of) chains. However, collecting data on a regional level to determine the value added there is often very difficult (Kaplinksy and Morris, 2001).

between the value that is added and the value that is captured by actors in that stage. This motivates firms that capture less than they add to move to a different stage in the chain if possible.

2.4 The Strength of Value Chains

2.4.1 Introduction in Competitiveness

In addition to researching the some elements in internal environment of value chains, there is a need for more information on the external environment when one wants to understand the complete functioning and position of a chain. If one wants to know how strong a chain is looking at the competitiveness is an option. This includes amongst other things looking at competing value chains, but also at the environment in which a chain is situated.

Porter has developed models to map the competitive environment on a micro, meso, and macro level. These three levels focus on the competitiveness of firms and small networks (micro-level), clusters, sectors and regions (meso level) and countries and supra-national regions (macro-level). On a meso level these models can be applied to determine the competitiveness of value chains as well. Porter’s Five Forces provides a model to analyse competitiveness within a specific sector. However, the circumstances surrounding this sector should not be ignored, as the environment in which a firm (or industry) is embedded, influences competitiveness as well through its strengths and weaknesses. Porter’s Diamond is a model which can be used in researching the factors that influence the relative ‘specialization’ of a country or region (Snijders, Vrolijk and Jacobs, 2007).

2.4.2 Competitiveness of Sectors

Figure 2.7: The Five Competitive Forces (Based on Porter, 1990)

Porter states that in every industry, domestic and international, producing products and services, ‘the rules of competition are embodied in the five competitive forces’ (1985; p4). The collective strength of these forces is what determines the profitability of an industry, as they influence prices, costs and required investments. These forces are the elements that shape industry structure, which is quite stable, but can be influenced by firms through their strategies. Barriers, which were also addressed in the discussion on rents and their distribution, are again an important concept. The higher the barriers to entry are, the smaller the threat of new entrants that could increase competition within a sector is. High barriers to entry and no threat of substitutes create a strong position for a firm, and can lead to a monopoly. However, it can also be the case that a supplier or buyer has a strong position, or is a monopolist, which gives a lot of power to these links in a chain (Snijders et al., 2007).

As value chains are not similar to each other, the opportunities of chains differ. However there are four different paths economic actors can follow to increase their competitiveness when they are threatened by competition. First, the efficiency of internal operations can be increased to become more efficient than rivals. Secondly the interfirm linkages can be enhanced compared to those of competitors. Third, a firm can introduce new products or improve existing products before the competition does. The last option is a change in the mix of activities that are conducted in a firm, or moving to different links in the chain (Kaplinsky, 2004). In the value chain approach suppliers and buyers should not be seen as a threat, as information should be shared amongst different links to increase the strength of the total chain.

2.4.3 Competitiveness of Regions

Porter’s Diamond (figure 2.8) provides a model to determine the competitive position of a sector or industry in a specific region. The success of firms is not only influenced by its own strategy, but also by its environment. Every country or region has a specific combination of strengths and weaknesses, which should be determining the basis of competition for a region, as it makes it more suitable for some sectors as for others. Therefore should not be an emphasis on competition on costs, but on differentiation according to Porter (Snijders et al, 2007). The ‘diamond’ is formed by four determinants, which create the context in which firms in a nation (or region) operate, and includes the role of chance and of the government (Porter, 1990).

As mentioned earlier, the related and supporting industries should strengthen each other’s position. More value is added when regions (and firms) focus on their strengths instead of imitating others, which only leads to competition and overcapacity. The process of innovation and upgrading benefits especially from home-based suppliers. Other advantages from competitive supplier industries in the same region can include access to cost-effective inputs, on-going coordination and open information flow. Related industries offer the same advantages, and increase the likelihood that new opportunities in an industry are perceived. In addition, the link between complementary goods can create first mover advantages. Firms can coordinate or share activities in the value chain when competing in related industries, or related industries offer complementary products.

Looking at the demand conditions the question rises to what extent they contributed to the competitiveness (internationally) of a certain sector. Three important elements should be considered, the first two being related to the nature of domestic buyers, namely the quantitative size and growth pattern and the qualitative characteristics of the home market. The final element concerns mechanisms by which the domestic preferences are transmitted to other markets, which could lead to competitive advantages outside the home market.

The factors of production are the inputs that are needed to compete in any industry, and can be grouped into a number of broad categories: human resources, physical resources, knowledge resources, capital resources and infrastructure. The more efficient and effective these factors are used, the better the competitiveness of a region or country. Porter distinguishes the factors on two levels, the first is a distinction made between basic and advanced factors, the second between generalised and specialised factors. Basic factors are passively inherited, or their creation requires relatively modest or unsophisticated private and social investment (e.g. natural resources, unskilled labour and location). Advanced factors however require large and often sustained investments in human and physical capital (e.g. research institutes, high skilled labour and modern infrastructure). Generalised factors can be deployed in a wide range of industries. On the other hand, specialised factors refer to factors that are only relevant to a limited range or even only a single industry.

Chance is a factor that influences the four determinants, as it creates discontinuities that might lead to shifts in competitive positions. Chance can alter the conditions of the diamond, the impact does not have to be similar for all regions and sectors however. The factor in itself is not as important as the way firms react on it, that is what makes the difference.

The last actor to influence the competitiveness of regions and countries by influencing the four determinants is the government. In addition, government can be influenced by all determinants as well. The dynamics of the ‘diamond’ can be stimulated or slowed down by measurements that are taken, for that reason it is important the government takes appropriate steps (Porter, 1990).

Governments have several roles to play in (global) value chains (Kaplinsky, 2004). The first being the provider of proactive assistance to the private sector, workers’ organisations and other stakeholders in recognizing opportunities and threats, especially those that are active in global value chains. Secondly, producers can be assisted in entering new (global) value chains. The third role refers to using policy to support the corporate sector in deriving a greater share of the gains of the value chain. The fourth and last role focuses on the access that should be provided to complementary assets. Snijders et al. (2007) add after discussing Porter’s models the importance of a government backing ‘winners’ in a region based on the strengths, instead of going for the same sectors everywhere.

2.5 Increasing Performance

Although analysing value chains comes with difficulties, as for instance calculation problems when using management accounting data, Shank and Govindarajan state that every firm should attempt to estimate its value chain, as even the process can be ‘quite instructive’ (1992; p184). The use of management accounting in this context and other possible applications of value chain analysis are explored below. Organisations can use these tools to reach more efficiency within the chain and increase competitiveness.

2.5.1 Management Accounting

Using management accounting data can give detailed and quantitative information about the different parts of the value chain, and about the connection between these parts. Below a short overview of different studies that used management accounting is provided.

Building a tree of gross output prices, beginning with raw material and ending with the sold final product, is a helpful tool for gaining insight in input-output relationships in the chain. A number of primary general accounting data can be obtained relatively easy (Kaplinksy and Morris, 2001). An overview of some of this data and how to obtain it can be found in table 2.5. This shows that although some questions can be answered with the help of accounting data and similar information sources, interviews are still a necessary tool in value chain analysis.

Primary accounting data

Where to find the data Required Calculation

Gross output values Annual report/balance sheet, interview with CEO or finance officer

Record turnover figures

Net output values Balance sheet, interview with finance function

Gross sales minus purchases of incoming materials and components

Physical flow of commodities

Outgoing volumes from production control, incoming volumes from inventory control and/or purchasing department

Tonnes, metres, litres, etc.

Flow of services, consultants and skills

Interviews with finance function, purchasing department

Payments for bought-in services and skills

Destination of sales Sales office Percentage of sales going to different

types of customers and markets, number of customers

Table 2.5: Sources for primary accounting data (Kaplinksy and Morris, 2001; p54)

ultimate end-use product for the final costumer (Dekker, 2003; p4). Managing the relationships between firms in this context can reduce costs and improve differentiation, and value chain analysis based on accounting information is a mechanism that facilitates the optimization and coordination of interdependent activities.

To perform this analysis, the value chain should be decomposed into value activities, which are the strategically relevant activities, and to which costs, revenues and assets should be assigned. The behaviour of costs and the sources of differentiation can be identified and insight can be gained how activities are interrelated. Customer’s and supplier’s actions can have a significant impact on the value activities of a firm, influencing the cost and differentiation position (Shank and Govindarajan, 1992). A given industry’s value chain can be thought of as the industry itself and the supplier (upstream) and customer (downstream) industries. An industry value chain can be determined with the help of input-output transactions, and by measuring the similarities of buyers and suppliers and with other industries in ratios. By setting threshold values for buyers or suppliers in order to assign them a key role within a chain the process can be made easier and provides a clearer overview. Putting different weights on different ratios can also help in simplifying, as the influence of enabling industries can be reduced (Feser and Isserman, 2009).

The distinct value activities are the building blocks that form the value chain, but the individual activities should be seen as interdependent (Shank and Govindarajan, 1992). For every stage costs, revenues and assets should be identified. However, several problems that are part of the construction of a value chain are mentioned. These include difficulties calculating value for intermediate products, isolating key cost drivers, identifying linkages across activities, and computing supplier and customer margins (Shank and Govindarajan, 1992; p184). The start is segmenting the chain into components for which, somewhere, a market exists. By identifying every point of the chain for which an external market exists, the process can be started. Meaningfully decoupling the stages of the value chain is often a difficult task, but it can provide interesting insights in decisions that firms make on what to buy, what to make and what to sell. This methodology is followed by identifying strategic options, assigning costs and revenues to the stages, estimating market value transfer prices, estimating asset investment and calculating accuracy.

willingness depends on the level of trust within the chain, but can also come from the implementation of formal controls (Dekker, 2003).

2.5.2 Benchmarking

By analysing the productive efficiency of different parties in the value chain the different links are benchmarked. Additionally, the challenges that confront the firm or other parts of the chain should not be ignored, as benchmarking does not stand on its own in general. Depending on the chain there are different possibilities on whom to benchmark against. This can be own historical performances, firms in the same sector or firms in other sectors that have similar processes. However, it can be difficult to receive access to data that is needed for benchmarking.

Two sets of data are important when looking at what should be benchmarked. The first kind of data concerns the sort of activities. It has mostly been applied to those activities that are involved in the physical transformation of inputs, but these are not always critical for the chain effectiveness. Therefore, other processes (e.g. in design, marketing and office activities) should also be included when possible and relevant. The second data deals with the distinction between measures of practices and performance outcomes (Kaplinsky and Morris, 2001).

The process of benchmarking described above provides firms within a value chain insight in their own performance and the performance of the chain. This way of comparing can lead to improvements that benefit not only the separate parts, but the whole chain. The outcomes can show where one is performing better than others, and where there is room for improvement.

2.5.3 Upgrading and Innovation