IE 463 Lecture 6 BOUNDARIES, FLOWS and INTEGRATION

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IE 463 Lecture 6 BOUNDARIES, FLOWS and
INTEGRATION
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BOUNDARIES of the FIRM

• Main Question What activities does the firm do
  itself or
• leave to the market?
• Firms organize activities internally or through
  markets
• for reasons of
• efficiency (cost management, TCE etc.)
• strategic positioning (strategic management, RBV
  etc.)

systems unit
firm
internal transaction
external supplier/ customer
external transaction
internal supplier/recipient
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• 1. Horizontal boundaries Quantities and
  varieties of
• goods and services produced by a firm (scale and
  scope
• of activities)
• Firm horizontal boundaries are determined by the
• following questions
• What market size is right for the firm?
• Which market is right for the firm? (The fit
  between firm size and market structure may depend
  on the market)
• Which cost or efficiency advantages of economies
  of scale/scope are important to the firm?

Economies of Scale (quantity) declining of
average cost when a larger volume of
goods/services are produced Economies of Scope
(variety) cost savings obtained when different
goods/services are produced
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• 2. Vertical boundaries activities in the
  vertical chain
• (value chain) performed by a firm (internal
  production,
• external supplier, internally and externally
  disposed
• outputs)
• Activities in the value chain include primary
  activities like,
• acquisition of raw materials, production, sale
  of final
• goods/services and after sale services
• as well as support activities such as,
• finance, marketing or human resource management

Value Chain The value chain categorizes the
generic value-adding activities of an
organization, representing a business as a chain
of value creating activities that transform
inputs into outputs It can apply to whole supply
chains and distribution networks.
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• Basic sources of the customer value
• activities that differentiate the product
• activities that lower its cost
• activities that meet the customers need

Firm Value Chain (Porters Generic Value Chain)
support activities
Firm Infrastructure Human Resource
Management Technology Development Procurement
marketing and sales
inputs
production
service
outputs
RD
primary activities
backward, upstream forward,
downstream
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• Often, chain activities ranging from product
  design, production of
• components and final assembly to delivery to the
  final customer are
• not done by a single firm but by different firms
  which become
• members of a value system.

supplier value chains
distribution/marketing channel value chains
customers
firm value chain
Linkages between different value chains
Distribution / Marketing Channel Marketing
organizations (individuals, systems and tools)
responsible for the flow of goods and services
from the producer to the end consumer.
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Primary Activities

• Inbound Logistics the receiving and warehousing
  of raw materials,
• and their distribution to manufacturing
• Operations the processes of transforming inputs
  into finished
• products and services
• Outbound Logistics the warehousing and
  distribution of finished
• goods
• Marketing Sales the identification of customer
  needs and the
• generation of sales
• Service the support of customers after the sale
  of products and
• services

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• Firm vertical boundaries are determined by the
  following
• questions
• Which activities in the value (vertical) chain
  are to be performed inside the firm?
• Which activities in the value (vertical) chain
  are to be out-sourced?
• If many of the value chain steps are performed
  in-house,
• the firm is vertically integrated.
• Example Goodyear
• If many of the value chain steps are out-sourced,
  the firm
• becomes vertically disintegrated.
• Example Dell, Nike

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THE BLURRING OF BOUNDARIES
Cus tomer
internal production system
flow of products, services and information
external suppliers
extended firm production system
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INTEGRATION

• Question What is the appropriate scale and
  scope of an
• enterprise?
• Firms grow externally through
• vertical integration
• horizontal integration
• conglomerate merger (merger or takeover of firms
  in different lines of business)

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VERTICAL INTEGRATION

• Vertical integration is the merger or takeover of
  firms
• (activities) which are at different stages of a
  value chain. It
• is a strategy to acquire control over additional
  links in
• value chain of producing and delivering
  products/services.
• Through vertical integration, a business expands
  its
• control over other businesses that are part of
  its overall
• manufacturing process. Firm can aim at either
  full
• or partial integration
• Ex An oil refining business would be vertically
  integrated
• if it owned or controlled pipeline companies,
  railroads,
• barrel manufacturers, etc.

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• 1. Backward integration moving closer to
  sources by
• acquiring resource suppliers or manufacturing the
  
• components needed for the final product. Firm
  reduces
• dependency on suppliers by purchasing them.
• Ex A construction company buying a construction
  
• materials producer.
• 2. Forward integration moving closer to
  end-user
• (market). Firm expands its products/services to
  related
• areas in order to more directly fulfill the
  customer's needs.
• Ex A manufacturer buying a transportation fleet.

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raw materials
engineering and design
backward integration
firm A
manufacturing
manufacturing
vertical integration
forward integration
retail stores
retail stores
firm B
after-sale service
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VERTICAL INTEGRATION AND ASSET OWNERSHIP
Possible Organizational Arrangements

• When firms are not integrated they remain
  independent.
• Each firm controls its own assets and makes its
  own
• operating decisions.
• When they are integrated
• Forward Integration Firm A owns the assets of
  Firm B and Firm A has control over both sets of
  operating decisions
• Backward Integration Firm B owns the assets of
  Firm A and Firm B has control over both sets of
  operating decisions

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Takeover of a Chip Company by a PC Manufacturer
Chip Company
Chip Company
Outside Manuf.
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Backward
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100
Outside Chip
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PC Manufacturer
PC Manufacturer
Forward
PC Retail
PC Retail
partial backward integration PC
manufacturer buys lt100 of the product utilized
and the Chip Company sells lt100 of the product
produced.
full backward integration
PC manufacturer buys 100 of the product
utilized and the Chip Company sells 100 of the
product produced.
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• Advantages of Vertical Integration
• Cost reductions (eg. transportation costs) when
  activities take place in close geographic
  proximity
• Improved supply chain coordination
• More product/service differentiation by means of
  increased control over inputs
• Improved downstream and upstream profit margins
• Increased entry barriers to potential
  competitors, for example, if the firm can gain
  monopoly control of a market or a scarce resource
• Gain access to downstream distribution channels
• Investment in highly specialized assets which
  otherwise would not be made by other players in
  the value chain
• Expansion of core competencies

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Disadvantages of Vertical Integration

• Capacity balancing issues for downstream and
  upstream
• activities (eg. the need to build excess
  upstream
• capacity to ensure that its downstream
  operations have
• sufficient supply under all demand
  conditions).
• Potentially higher costs due to low efficiencies
  resulting
• from lack of supplier competition.
• Decreased flexibility due to previous forward or
  backward
• investments (however, the flexibility to
  coordinate
• vertically-related activities may increase).
• Decreased ability to increase product variety if
  significant
• in-house development is required.
• Difficulty of developing new core competencies
  when the
• existing competencies are deep rooted in the
  value chain.
• Increased bureaucratic costs.

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HORIZONTAL INTEGRATION

• Horizontal integration is the merger or takeover
  of firms
• at the same stage of the value chain. A firm
  growing by
• the acquisition of a competitor will increase its
  market
• share with new products that are similar to its
  current
• lines. It can be a strategy to sell one type of
  product in
• numerous markets.
• Ex A media company's ownership of radio,
  television,
• newspapers, books, and magazine.

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raw materials
engineering and design
manufacturer A
manufacturer B
manufacturing
horizontal integration
retail stores
after-sale service
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• Advantages of Horizontal Integration
• Economies of scale, acheived by selling more of
  the same product, for example by geographic
  expansion.
• Economies of scope, achieved by sharing resources
  common to different products (commonly referred
  to as "synergies).
• Increased market power (over suppliers and
  downstream channel members).
• Reduction in the cost of international trade by
  operating factories in foreign markets.

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• Disadvantages of Horizontal Integration
• Significant concentration of industry by a single
  firm may create legal issues like anti-trust.
• The anticipated economic gains will not always
  materialize, nor the expected synergies will
  exist (eg. computer hardware manufacturers who
  entered the software business on the premise that
  there were synergies between hardware and
  software may realize that a connection between
  two products does not necessarily imply
  realizable economies of scope).
• Even when the potential benefits of horizontal
  integration exist, they do not materialize
  spontaneously (there must be an explicit
  horizontal strategy in place).

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BUYER- SUPPLIER RELATIONSHIP SPECTRUM
Acceptance ofMutual Goals
Arms LengthRelationship
FullPartnership
Confrontation
Traditional Relationship ConfrontationSuspicion
Outsourcing
New Relationship CooperationTrustOutpartnering
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RELATIONSHIP WITH SUPPLIER
OUTSOURCING
OUTPARTNERING
Process (capability) buys Access to technical
market
information New technology/processes Rationalizati
on
Product (capacity) buys Reduced direct costs
Expertise Flexibility Name recognition Rationaliza
tion
Product (capacity) Buys A relatively low-cost,
high-quality purchase of inputs from external
suppliers, as a substitute for internal
production Process (capability) Buys A purchase
that results from an intimate relationship
between the knowledge bases, capabilities, and
processes of the two firms
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SUPPLY CHAIN

• The system of suppliers, manufacturers,
  transportation,
• distributors, and vendors that exists to
  transform raw
• materials to final products and supply those
  products to
• customers, containing
• raw materials, work-in-process, and finished
  goods in inventory
• information, money, and people associated with
  this system
• value flow, logistics and distribution channels

suppliers manufacturer
distributor retailer
customer
finished goods, end products and services
package and delivery
materials, parts, sub-assemblies and services
satisfaction with quality,price, delivery and
service
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BASIC SUPPLY CHAIN and DOMINANT FLOWS
flow of order and cash
flow of products and services
customer
supplier
manufac-turer
distribution system
physical distribution
manufacturing planning and control
physical supply
information
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• Flows
• 1. Downstream flows
• Information Capacity, promotion plans, delivery
  
• schedules
• Materials Raw materials, intermediate products,
  
• finished goods
• Finance Credits, consignments, credit terms,
• invoice
• 2. Upstream flows
• Information Sales, orders, inventory,
  quality,
• promotion plans
• Materials Returns, repairs, servicing,
  recycling,
• disposal
• Finance Payments, consignments

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DEMAND CHAIN

• A demand chain is composed of the enterprises
  that sell a businesss goods or services. It
  transfers demand from markets to suppliers.
• For example, a demand chain may be composed of
• buyers who initiate the sales transaction, the
  resellers
• who sell the manufacturers goods, and the
  manufacturer who creates the goods
• resellers who sell a manufacturers goods, the
  manufacturer who makes the goods, and the
  distributors who supply the manufacturers goods
  to the resellers
• Ex A retailer's demand chain would consist of
  assortment planning (deciding what to sell),
  inventory management (deciding the quantity of
  supplies needed), and procurement (deciding the
  other details of the actual purchase)

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INTEGRATING DEMAND AND SUPPLY

• The demand chain, together with the supply chain
  form
• the demand- supply chain. They are linked in
  two places,
• the supply-fulfillment point (SFP) and
• the demand-offering point (DOP).
• The SFP is the place in the supply chain where
  the supplier allocates the goods ordered by the
  customer.
• The demand-offering point (DOP) is where the
  supplier fulfills demand in the customer's demand
  chain.

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• Often, companies focus on either the supplier
  base or the
• customer side, but not both. For the integration
  of supply
• and demand management
• focus on customers demand chain (e.g.,
  assortment planning, inventory management, and
  procurement)
• determine optimal linkage point between demand
  chain (DOP) and supply chain (SFP)
• the further back SFP is in the supply chain, the
  more challenging it becomes to fulfill orders
  promptly (e.g., build to order vs. build to
  forecast)
• moving DOP further back in the demand chain
  toward customer largely benefits the customer and
  requires more work by the supplier. This means,
  instead of fulfilling orders from wholesalers,
  fulfilling orders by going to the end consumer
  (customised service)

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• 1. Offer to purchase
• In the conventional, arm's-length buyer-seller
  relationship, the DOP is the purchasing
  department, which accepts an "offer to purchase"
  by choosing the supplier and deciding when goods
  are needed.
• 2. Offer to manage inventory
• DOP is moved further back in the demand chain. By
  carefully monitoring the customer's inventory
  levels, a supplier can cut down on stock that is
  unlikely to sell and ensure that the customer
  never runs out of goods that move briskly. These
  benefits, however, mean more work for the
  supplier, since it must now have a separate
  inventory control process for each customer.
• Offer to plan
• DOP is moved back to merchandizing (in the case
  of retailing) or production (e.g., automotive and
  computing industries). In other words, by
  joining forces to analyze the consumer demand
  categories served by products from the supplier,
  both retailer and supplier can avoid new products
  or promotions that lack a significant market.
  Suppliers are

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also expected to use this kind of collaboration
to improve their delivery performance. The result
is a more profitable use of retail space by
retailers, but unless suppliers can charge a
premium or increase their sales through this kind
of collaboration, they do not benefit from it.
4. Offer to end use An example is Dell
Computer's direct sales model for business
clients. Rather than fulfill orders from
wholesalers (an offering to purchasing), Dell
went all the way back in the demand chain to the
end consumer by fulfilling orders for customized
PCs-complete with software and network
configuration. All employees have to do is turn
on their machines. Corporate customers reap an
enormous advantage the ability to eliminate half
of their PC support teams, which spend most of
their time setting up computers. Although moving
the DOP back in the demand chain appears to be in
the customers interest, the supplier can benefit
if it simultaneously moves the SFP. By
coordinating movements in both the demand and
supply chains, suppliers improve their customers
performance and at the same time generate
efficiency in their own operations.
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• Dell provides excellent direct service to the end
  user because it moved its supply-fulfillment
  back in the supply chain by assembling to order
• College textbook industry
• McGraw-Hill moved its demand-offer from
  bookstore to the instructor, and its
  supply-fulfillment from the warehouse to the
  retailer. McGraw-Hills Primis system
  (electronic-publishing system) allows instructors
  to customize textbooks with reading
  complementary materials from a variety of sources
• - materials are combined into a single package
  that is
• printed and bound in the bookstore
• - benefits faster delivery time to end user,
  no excess
• inventory, no returns, better product (i.e.,
  no unused
• portions of textbook), lower costs for all
  parties

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DEMAND - SUPPLY CHAIN
satisfy and manage demand for products and
services
SUPPLY CHAIN

create, develop and sustain demand for products
and services (RD, marketing, sales, after sales
services, customer relations, ...)
DEMAND CHAIN
DEMAND- SUPPLY CHAIN
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VALUE NETWORKING
suppliers manufacturers distributors
retailer s customer

Value Strategy





Network Infrastructure





Logistics Operations
suppliers manufac- distributors
retailers customers
turers
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SUPPLY NETWORK

• Supply network (also called supply chain network)
  is an
• extension where components and prosesses are
• connected in parallel in the full supply chain
  environment
• (different tiers and vendors working together).
  It is a
• network of facilities that performs functions of
• procurement of materials
• transformation of materials to intermediate and
  finished products
• distribution of products to customers.
• In this network of autonomous entities,
• similar concepts
• principles
• problems
• tasks
• are organized to improve network productivity.

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• The purpose of a supply network is to transform
• incomplete information about the market and
  resources
• into coordinated plans for production and
  replenishment
• of goods and services in the network of
  cooperating
• entities,
• synchronization among multiple autonomous
  entities
• (coordination between and within members)
• reduction in lead times and costs, alignment of
• interdependent decision processes,
  improvement in the overall performance of each
  member as well as the network

Lead Time The total time a customer, internal
or external, must wait to receive a product after
placing an order (time it takes a supplier to
deliver goods after receipt of order)
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CASE NIKE
High End refers to the best and generally most
expensive of a class of goods or services.
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AUTOMOTIVE INDUSTRY
OEM - Original Equipment Manufacturer Firm that
uses unbranded supply products and brands the
final product
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INTER- FIRM CHAIN LINKS
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THE TRANSITION IS FROM LINEAR SUPPLY CHAIN
Retailer
Value-Added
Manufacturer
Distributor
Reseller
End User
Suppliers
Corporate
Reseller
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TO DYNAMIC SUPPLY (CHAIN) NETWORKS!
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VERTICAL COLLABORATION
Vertical collaboration is formed between firms
that use their complementary capabilities and
skills to create value at different stages of the
value chain. It includes distribution, supplier
or outsourcing partnerships where firms rely on
upstream or downstream partners in a chain to
build competitive advantage.
Firms combine their complementarities to supply
the overall production activity in a value chain.
As the supplier and customer interact along the
chain, the market type input/output relationship
allows firms knowledge creation.
Buyer-side Value Chain
vertical collaboration
Supplier-side Value Chain
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HORIZONTAL COLLABORATION

• Horizontal collaboration is formed between firms
  that
• combine their similar capabilities and skills to
  create value
• at the same stage of the value chain. Even
  though the
• partners may actually are or become competitors
  in the
• business
• firms can focus on long-term product development
  and distribution opportunities,
• achieve economies of scale,
• provided that a great deal of trust exists
  between them.

Firms with similar capabilities and chain
activities can learn from each other more
effectively. Learning from rivals stimulates
innovation and its diffusion.
horizontal collaboration
Partner 1-side Value Chain
Partner 2-side Value Chain
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DIMENSIONS OF SUPPLY CHAIN INTEGRATION
Dimension Exchanges How
information integration information, knowledge information sharing, knowledge sharing
coordination, resource sharing decisions, work decision delegation, work realignment, outsourcing
organizational relationship linkage accountability, risks/costs/gain extended communication and performance metrics, incentive realignment
Metric A standard of measurement of performance