Constructing the Value System


Entrepreneur Success Series

Resource Note # 13

The last issue SATTVA provided a comprehensive introduction to the concept of Value and the Value system. Having understood comprehensively the concept of Value, the next step for an entrepreneur is to understand how the Value System is constructed. This will help them position their organisation appropriately in the Value System. It also gives them an idea of which position is most desirable from the angle of profits, and this is one more input to shape the business idea.

1.         Understanding the Organization Value Curve

The Organisation Value Curve is a concept introduced by W Chan Kim and Renee Mauborgne. It is a graphic depiction of the cluster of values that an organization offers to its market segment. As mentioned in the previous edition, some values are order winning CSFs while the rest are market entry values. This combination of ‘order winning’ and ‘market entry’ parameters constitute the Value Curve of the organization. For example, the Value Curve of the Tata Nano comprises low price and fuel efficiency as as order winning and parameters like performance, safety, space for family all as Market entry. As a Service example, the Value Curve of a budget hotel (Formule 1) and two competitors is shown in Figure 1.

Fig. 1: Value Curve of a Budget Hotel (Formule 1) and two competitors

Source: http://users.tkk.fi/u/phannuka/articles/Kim_Mauborgne_1996_Value_Innovation.pdf.

The figure shows that Formule 1 offers bed quality, hygiene and room quietness as its order winning CSFs and the rest as market entry. The order winning CSFs are superior to the competitors but market entry values need some improvement to attract more customers.

Chan and Maugborne suggested four ways to alter the Value Curve of an organization, in line with market exigencies:

A Value Curve analysis as above will help an entrepreneur decide the exact parameters in their product or service

It is very rare to find a single organization being able to deliver the complete set of the Value Curve on its own. A Value System (i.e. a chain of organisations that contribute specific value to the value curve) is put together for this purpose. The position in the Value System for the entrepreneur’s offering gets automatically fixed. However this may not be the best position in a Value System. An understanding of the Industry Value Curve is essential to understand what the best position is.

2.         Understanding the Industry Value Curve

The Industry Value Curve is best understood through an example. Figure 2 is an illustration of a pharmaceutical Industry Value Curve 

Fig. 2: Pharmaceutical Industry’s Value Curve

Source:http://hbr.org/2000/03/going-global-lessons-from-late-movers/ar/6

Each position on the curve represents a product market segment of the pharmaceutical industry e.g. intermediates and bulk drugs. Organizations in this segment get a gross margin of 2% – 12%,whereas organizations in the knowledge domain leading to new molecule discovery get an average of 60% to 100%. margin. This is the basis for identifying ‘profitpools’ in upstream, midstream and downstream positions. In this industry, higher the technological complexity in a product position, greater the margin. The increase in margins does not necessarily represents downstream positions in the Value System e.g. Drug discovery is at the head of the Value System but its margin is the highes

An organization would ideally seek a position which can maximize its profit potential, but the final fit is determined by its competences and business objectives. The organization takes stock of its capabilities and reaps returns according to its capabilities. Moving up the industry Value Curve means getting a higher margin for the value offered. Referring to Fig 2, companies in commodity genetics are higher up in the industry value chain as compared to companies in bulk and intermediaries.

A position in an industry Value Curve can either have a direct B2B, B2C or both markets:

Sometimes an organization may straddle two product segment of the industry Value Curve. For example W L Gore owns both the grey division as well as the dyeing division. Such an organization is said to be vertically integrated. 

Another example from the computer industry is shown in Figure 3

Fig. 3: Value Curve in the IT related manufacturing industry

Source: http://en. wikipedia.org/wiki/File:Smiling_Curve.svg

Here the x-axis is a progression as seen in the position in the Value System while Value (read Margin) is on the Y-axis. Thus there are 2-3 ways in which the Industry Value Curve is drawn

Profit Pool is yet another way of looking at the Industry Value Curve. It is defined as “the total profits earned in an industry at all points along the industry value chain” (Gadiesh and Gilbert, HBR, May-June 1998). It is different from the earlier curves in the sense that it considers Market (Revenue) Share versus Operating Margin. Figure 4 is an example from the Auto Industry This shows that Market Share and Returns are not necessarily co-related. Auto Leasing, with a miniscule Market Share, has the highest returns.

Fig. 4: Profit Pool of US Auto Industry

Source: Gadiesh and Gilbert, Harvard Business Review, May-June 1998

Some examples of where maximum profits are found in different industries is shown in the table below:

Profit Pools Examples from Different Industries

IndustryCore BusinessSources of Highest ROI
AutomakersAuto manufacturingLeasing, insurance, service.
U-HaulTruck RentalPacking materials, storage
Elevators (OTIS)Elevator ManufacturingService
IomegaZip DrivesZip Disks; Storage
PolaroidInstant Photography CamerasFilm

Source: James Oldroyd, Kellogg Graduate School of Management, Northwestern University – downloaded from the net

Gadiesh and Gilbert have given a Four Step Process of how to map the profit pool of an industry (Fig 5). This could be helpful guidelines for an entrepreneur in trying to understand the Value Curve concept in their own context

Fig. 5: Four Step Process to Map the Profit Pool of an Industry

Source: Gadiesh and Gilbert, Harvard Business Review, May-June 1998

3.         Understanding Network Structures

An understanding of the organization Value Curve, Industry Value Curve and Industry Profit Pool can give a strategic direction to an organisation’s choice of which industry is attractive, which segment to service and which position to take in the Value System. An understanding of industry structures will help in deciding the most effective structure for the purpose. The structure determines how responsibilities and interactions flow amongst the member organisations in the Value System. It should be noted by the entrepreneur that knowledge of network structures will not have a great influence on the Business Decision but indicates Strategies for Operations. There are three basic structures – Hierarchical, Mixed and Constellation. 

The Hierarchical Structure (Fig 6) is a top-down structure from OEM to suppliers, arranged in hierarchical tiers. 

Fig. 6: Hierarchical Structure

Source: Petrick and Pogrebnyakov in Dwivedi and Butcher, pg 9 fig 1.4)

The OEM has the greatest knowledge of the end consumer due to close proximity to them. The OEM translates its understanding of the customers’ needs into product features and passes it down the chain. Only the OEM interacts with the customer; Only Tier 1 suppliers interact directly with the OEM; and so on down the chain. Information about the needs of the customer flow upstream in one direction. Such a structure is seen mostly in the flow of tangible products through the Value System e.g in heavy engineering industry or the automobile industry. 

The Mixed Structure (Fig 7) has less rigid tier structure and multiple paths to the OEM. 

Fig. 7: Mixed Structure

Source: Petrick and Pogrebnyakov in Dwivedi and Butcher, pg 9 fig 1.4)

Some non-tier 1 suppliers interact directly with the OEM and frequently work as co-designers with OEMs. In the automotive industry, supplier of fuel injection technology co-design the product with the OEMs and then supplied to tier 1 engine supplier for further assembly. This is basically for ideas and information flow, but material still flows in one direction

Constellation Structure (Fig 8) has very little or even no tiers – value is not obtained through sequential chains but through a complex constellation network of suppliers. 

Fig. 8: Constellation/ No Tier Structure:

Source: Petrick and Pogrebnyakov in Dwivedi and Butcher, pg 9 fig 1.4)

Take IKEA as an example. It is not at any value point in a chain but is a central star in a constellation of services, goods, design, management, and support which is provided by separate organizations under the IKEA umbrella. This network relies not on structure but on relationship. Suppliers, customers, allies and business partners work in new combinations and relationships to co-produce value. Leadership is not of the OEM but any company which has unique intellectual property. 

In the automotive industry, network relationship can be seen in designing as well as product assembly.  ‘Dispersed designing’ in a network can see an engine being designed by multiple partners, each with expertise in the block, head, injection systems, and soon. This ‘constellation’ comes together in a temporary relationship for the design purpose and then breaks apart. Similar is the case in software development

Product assembly can also use constellation networks. Different companies independently design and produce components (modules) according to a given set of design rules. Unlike Hierarchical and Mixed structures, here the OEM does not give the design; rather different companies have their standard modular designs which the OEM buys and puts together in the final product. E.g. in a sports utility automobile, the entire driver’s cockpit including air bags, heating and air-conditioning systems, instruments, steering column and wiring harness is produced separately as a sub-assembly and fitted directly on the assembly line.

For a Value System to be effective, it has to have collaboration amongst its members to be able to deliver ultimate customer value. Collaboration in a supply network has a variety of options like planning, forecasting, vendor managed inventory, and knowledge sharing. This helps transparency as well as synchronization. The network structures described have been researched for collaboration efficiencies. The results are as follows:

4.         Constructing the Value System

Construction of a Value System can be understood by a few simple questions as shown in Figure 9.

  
What is the ultimate consumer segment to be served A strategic decision of the top level stakeholders
What Value Curve is to be adoptedAligned to CSFs and Market entry values of the consumer segment
Where to position the organization in the industryGuided by the industry Value Curve and Profit Pools
Where to position the organization in the Value SystemDepending on the Value Chain of the organisation
What structure of relationships to adoptAs guided by the understanding of the Value System structures
How to deliver the valuesThrough an understanding of the Strengths and Weaknesses in the Value Chain

Exhibit 9: Constructing a Value System – guidelines

This is a simple roadmap in the Value System ‘jungle’ for the entrepreneur

Caveat:Though the above exhibit is listed linearly, the actual decision is a multiple iterative process of all the factors. Likewise the following summary of the characteristics of a Value System may also be helpful to the entrepreneur

References

Kim, Chan W and Mauborgne, Renee (1997), Value Innovation: The Strategic Logic of High Growth, HBR, Jan-Feb 

http://businesscasestudies.co.uk/nestle/coffee-the-supply-chain/introduction.html#axzz3CadV1crR

http://hbr.org/2000/03/going-global-lessons-from-late-movers/ar/6

http://www.funggroup.com/eng/knowledge/presentations/ 05.pdf(Li and Fung Dispersed Mfg)

http://en. wikipedia.org/wiki/File:Smiling_Curve.svg

James Oldroyd, Kellogg Graduate School of Management, Northwestern University 

Gadiesh, Orit and Gilbert, James L (1998), Profit Pools: A Fresh Look At Strategy, Harvard Business Review, May-June 1998

Gadiesh, Orit and Gilbert, James L (1998), How to Map Your Industry Profit Pool,Harvard Business Review, May-June 1998

Butcher, Tim and Dwivedi, Ashish, eds (2009), Supply Chain Management and Knowledge Management,Palgrave Macmillan

You may also like

Mentorship Mastery

Transformational Leadership

Entrepreneurial Synergy

LEAVE A COMMENT