Value Chains Om4 CH 2

VALUE CHAINS
CHAPTER 2
DAVID A. COLLIER AND JAMES R. EVANS
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or 1
posted to a publicly accessible website, in whole or in part.
CHAPTER 2 VALUE CHAINS
2-1 Explain the concept of value and how it can be

increased.
2-2 Describe a value chain and the two major
perspectives that characterize it.
2-3 Explain outsourcing and vertical integration in value
chains.
2-4 Explain offshoring and issues that managers must
consider in offshoring decisions.
2-5 Identify important issues associated with value
chains in a global business environment.
2-6 Describe how sustainability plays an important role
in value chains.
©2014 OM4 Cengage Learning. All Rights Reserved. May not be scanned, copied or 2
duplicated, or posted to a publicly accessible website, in whole or in part.
A pple has mastered the art of blending physical goods

with services to create value for its customers. Think iPod +
iTunes, iPhone/iPad + apps, Apple stores + Genius Bar; well,
you get the picture. Managing all operations involved from
the creation of goods and services through their delivery to
the customer and post-sale services – which we call the value
chain – is one of Apple’s core competencies. “Operations
expertise is as big an asset for Apple as product innovation or
marketing,” says Mike Fawkes, the former supply-chain chief
at Hewlett-Packard. “They’ve taken operational excellence to
a level never seen before.” Apple controls every piece of the
value chain.
For example, managers and engineers often work at supplier

and manufacturer sites to refine their operations, and
designers work with suppliers to create new tooling equipment.
When the iPad 2 debuted, Apple employees monitored every
handoff point—suppliers, production, loading dock, airport,
truck depot, and distribution center—to make sure each unit
was accounted for and of the highest quality. Apple’s retail
stores give it a final operational advantage. The company can
track demand by the store and by the hour, and adjust
production forecasts daily. If it becomes clear a given part will
run out, teams are deployed and given approval to spend
millions of dollars on extra equipment to get around the
bottleneck. Apple’s significant profit margins are in large part
due to this focus on operational excellent in its value chain.
What do you think?

Cite some other
examples in which digital
content has been
combined with a physical
good. How do you see
the digital revolution
changing the nature of
physical goods in the
future?
Value and Supply Chains

• A value chain is a network of facilities and
processes that describes the flow of goods,
services, information, and financial transactions
from suppliers through the facilities and processes
that create goods and services and deliver them
to customers.
• A supply chain is the portion of the value chain
that focuses primarily on the physical movement
of goods and materials, and supporting flows of
information and financial transactions through the
supply, production, and distribution processes.
The Concept of Value

• The underlying purpose of every organization
is to provide value to its customer and
stakeholders.
• Value is the perception of the benefits

associated with a good, service, or bundle of
goods and services (i.e., the customer benefit
package) in relation to what buyers are
willing to pay for them.
Perceived benefits
Value =
Price (cost) to the customer
If the value ratio is high, the good or service is perceived

favorably by customers, and the organization providing it is
more likely to be successful. To increase value, an
organization must:
(a) increase perceived benefits while holding price or cost

constant,
(b) increase perceived benefits while reducing price or cost, or
(c) decrease price or cost while holding perceived benefits
constant.
Value Chain Paradigms and Perspectives

• Input-Output Model: A value chain begins
with suppliers who provide inputs that are
transformed into value-added goods and
services through processes that are supported
by resources such as equipment and facilities,
labor, money, and information. These goods
and services are delivered or provided to
customers and targeted market segments.
Exhibit 2.1 An Input-Output Perspective of a Value Chain
Exhibit 2.2 Examples of Goods-Producing and Service-Providing Value Chains
Buhrke Industries, Inc. Value Chain

• Buhrke Industries Inc., located in Arlington Heights,
Illinois, provides stamped metal parts to many
industries, including automotive, appliance, computer,
electronics, hardware, house wares, power tools,
medical, and telecommunications.
• Buhrke’s objective is to be a customer’s best total-value

producer with on-time delivery, fewer rejects, and
high-quality stampings. However, the company goes
beyond manufacturing goods; it prides itself in
providing the best service available as part of its
customer value chain.
Exhibit 2.3 The Value Chain at Buhrke Industries
Source: Buhrke Industries

company web site
Buhrke Industries, Inc. Value Chain

• Service is more than delivering a product
on-time. It’s also partnering with customers
by providing personalized service for fast,
accurate response; customized engineering
designs to meet customer needs; preventive
maintenance systems to ensure high machine
uptime; experienced, highly trained, long-term
employees; and troubleshooting by a
knowledgeable sales staff.
Value Chain Paradigms and Perspectives

• Pre- and Postproduction Services
Perspective: Pre- and postproduction services
complete the ownership cycle for the good or
service. Pre-production services are focused on
“gaining a customer.” Postproduction services
focus on “keeping the customer.” This view of
the value chain emphasizes the notion that
service is a critical component of traditional
manufacturing processes.
Exhibit 2.4 Pre- and Post-Service View of the Value Chain
Nestle—A Service View of a Business

• Nestle defines its business initially from a
physical goods viewpoint; later from a service
perspective.
• The results were greatly increased Nestle coffee
sales, new revenue opportunities, and much
stronger profits.
• Nestle’s service vision of their business required
a completely new service and logistical value
chain capability.

A supply chain is the portion of the value chain
that focuses primarily on the physical movement
of goods and materials, and supporting flows of
information and financial transactions through the
supply, production, and distribution processes.
Many organizations use the terms “value chain”

and “supply chain” interchangeably; however, we
differentiate these two terms in this book.

A value chain is broader in scope than a supply
chain, and encompasses all pre- and
postproduction services (see Exhibit 2.3) to create
and deliver the entire customer benefit package.
A value chain views an organization from the

customer’s perspective—the integration of goods
and services to create value—while a supply
chain is more internally-focused on the creation
of physical goods.
Exhibit 2.4 Pre- and Post-Service View of the Value Chain
Exhibit 2.5 A Value Chain Model of Dell, Inc.
Value Chain Decisions

The operational structure of a value chain is
the configuration of resources such as suppliers,
factories, warehouses, distributors, technical
support centers, engineering design and sales
offices, and communication links.
Value chains may be centralized or

decentralized.
Outsourcing and Vertical Integration

• Vertical integration refers to the process of
acquiring and consolidating elements of a value
chain to achieve more control.
• Backward integration refers to acquiring
capabilities toward suppliers, while forward
integration refers to acquiring capabilities
toward distribution or even customers.
• Outsourcing is the process of having suppliers
provide goods and services that were
previously provided internally.
Three Waves of Outsourcing

1. Outsourcing goods-producing jobs, such as computer
components and electronics from the U.S. in many
industries several decades ago.
2. Outsourcing simple service work, such as standard

credit card processing, billing and other forms of
transaction processing, and software development.
3. Outsourcing skilled knowledge work, such as

engineering design, architectural plans, call centers,
and computer chip design.
The Economics of Outsourcing

VC1 = Variable cost/unit if produced
VC2 = Variable cost/unit if outsourced
FC = Fixed costs associated with producing the part
Q = Quantity produced (volume)
Total cost of production = (VC1)Q + FC
Total cost of outsourcing = (VC2) Q
Find the breakeven point: (VC2)Q = (VC1)Q + FC
FC
Q* = [2.1]
VC2 − VC1
Solved Problem—In-House versus Outsource

Suppose that a manufacturer needs to produce a
custom aluminum housing for a special customer order.
Because it currently does not have the equipment
necessary to make the housing, it would have to acquire
machines and tooling at a fixed cost (net of salvage
value after the project is completed) of $250,000. The
variable cost of production is estimated to be $20 per
unit. The company can outsource the housing to a
metal fabricator at a cost of $35 per unit. The customer
order is for 12,000 units. What should they do?
Solution
VC1 = Variable cost/unit if produced = $20
VC2 = Variable cost/unit if outsourced = $35
FC = fixed costs associated with producing the part = $250,000
Q = quantity produced
Using Equation 2.1 we obtain:

Q = 250,000/($35 - $20) = 16,667
In this case, because the customer order is for only 12,000

units, which is less than the break-even point, the least cost
decision is to outsource the component.
Solution – Excel Model of Outsource Solved Problem
Value chain integration is the process

of managing information, physical goods,
and services to ensure their availability at
the right place, at the right time, at the
right cost, at the right quantity, and with
the highest attention to quality.
Value chain integration in manufacturing

• Consolidating information systems among suppliers,
factories, distributors, and customers.
• Managing the supply chain and scheduling factories.
• Studying new ways to use technology.
Value chain integration in services

• Third-party integrators for the leisure and travel industry
(e.g., Orbitz, and Travelocity).
• Information networks provided by third-party information
technology integrators.
• Third-party integrators that manage patient billing and
hospital inventories.
Offshoring is the building, acquiring, or

moving of process capabilities from a
domestic location to another country location
while maintaining ownership and control.
Exhibit 2.7 Things to Consider When Making Offshore Decisions
Value Chains in a Global Business Environment

A multinational enterprise is an organization that
sources, markets, and produces its goods and
services in several countries to minimize costs, and
to maximize profit, customer satisfaction, and social
welfare.
Challenges Facing Multinational Enterprises

1. How to design a value chain to meet the slower growth
of industrialized countries and more rapid growth of
emerging economies.
2. Where to locate manufacturing and distribution facilities
around the globe to capitalize on value chain efficiencies
and improve customer value.
3. What performance metrics to use in making critical value
chain decisions.
4. How to decide if partnerships should be developed with
competitors to share engineering, manufacturing, or
distribution technology and knowledge.
Rocky Brands, Inc.

• Rocky Brands (www.rockyboots.com) headquartered in
Nelsonville, Ohio, manufactures rugged leather shoes for
hiking and camping.
• Rocky Brands began making boots in 1932 as the
William Brooks Shoe Company with an average wage
rate of 28 cents per hour. In the 1960s, Rocky Brands
were 100% “Made in America.” In 1960, more than 95
percent of all shoes sold in America were made in
America.
• Timberland, Wolverine, and Rocky are popular
brand names for this shoe market segment.
Rocky Brands, Inc.

The principal characteristics of this global value chain:
1. Leather is produced in Australia and then shipped
to the Dominican Republic.
2. Outsoles are purchased in China and shipped to Puerto Rico.
3. Gor-Tex fabric waterproofing materials are made in the United
States.
4. Shoe uppers are cut and stitched in the Dominican Republic,
and then shipped to Puerto Rico.
5. Final shoe assembly is done at the Puerto Rico factory.
6. The finished boots are packed and shipped to the warehouse
in Nelsonville, Ohio.
7. Customer orders are filled and shipped to individual stores and
contract customers from Nelsonville.
Exhibit 2.8 Rocky Brands, Inc. Value Chain
Rocky Brands Global Challenges

• Profit margins are only about 2 percent on sales of over
$100 million, while Timberland sales top $1 billion and
have a 9 percent profit margin.
• After seventy years in Nelsonville, the main factory closed
in 2002. At that time, local labor costs were about $11 per
hour without benefits, while in Puerto Rico the hourly rate
was $6; in the Dominican Republic, $1.25; and in China,
40 cents.
• The price of boots continues to decline globally from
roughly $95 a pair to $85, and is heading toward $75. The
grandson of the founder of Rocky Brands said, “We’ve got
to get there, or we're not going to be able to compete.”
Issues for Managing Global Value Chains

• Global value chains face higher levels of risk and
uncertainty, requiring more inventory and day-to-day
monitoring to prevent product shortages. Workforce
disruptions, such as labor strikes and government
turmoil in foreign countries, can create inventory
shortages and disrupting surges in orders.
• Transportation is more complex in global value chains.

For example, tracing global shipments normally involves
more than one mode of transportation and foreign
company.

• The transportation infrastructure may vary considerably
in foreign countries. The coast of China, for example,
enjoys much better transportation, distribution, and
retail infrastructures than the vast interior of the
country.
• Global purchasing can be a difficult process to manage

when sources of supply, regional economies, and even
governments change. Daily changes in international
currencies necessitate careful planning and in the case
of commodities, consideration of futures contracts.

• International purchasing can lead to disputes and legal
challenges relating to such things as price fixing and
quality defects.
• To extend the firm’s value chain to other nations requires
an understanding of national cultures and practices.
• Privatizing companies and property is another form of
major changes in global trade and regulatory issues.
• The pre-planning, response, and recovery from natural or
man-made disasters—often called Disaster or Emergency
Management—is another important part of value chain
management.
Sustainable Value Chains

• The terms green operations, green manufacturing,
and green practices are often used to describe
sustainability activities that involve operations and the
value chain.
• Sustainability improves the organization’s perception
among consumers, and improves the bottom line through
reduced costs.
• Sustainable practices can lead to increased revenues. For
example, organizations that emit greenhouse gases like
factories and electrical utilities may one day buy and sell
carbon credits in a commodities-type stock market.
• Many customers favor products and services that are
designed and produced in a sustainable way.
Sustainable Value Chains

OM practices for environmental sustainability:
• Designing goods and services using recyclable and
environmentally-friendly materials.
• Remanufacturing.
• Designing facilities and using equipment that conserve
energy.
• Using electronic media and technology to reduce paper
and fuel.
• Using transportation modes that minimize costs and
carbon output.
• Cleaning and reusing water used for manufacturing.
Bookmaster Case Study

1. Draw the “bricks and mortar” process stages by which hardcopy
books are created, distributed, and sold in retail stores. How
does each player in the value chain make money?
2. Draw the process stages for creating and downloading an eBook
today. How does each player in this electronic/digital value
chain make money?
3. Compare and contrast the value chain design and structure in
the previous two questions from customer and management
viewpoints. What are the advantages/disadvantages to each
value chain design?
4. What is the role of operations in each of these value chain
designs and structures?
5. What other criteria and issues are important in critiquing these
two different value chain designs?
Extra Slide: Save a Tree—and Much More

One issue of the Quadrangle—a University of Kentucky alumni College of
Engineering magazine—noted that, “This issue was printed with vegetable
ink on 12,125 pounds of paper made with 100% post consumer recycled
fiber. The resulting environmental savings are:
• 41,954 lbs of wood—a total of 145 trees that supply enough oxygen for 73
people annually;
• 53,050 gallons of water—enough water to take 3,084 eight-minute showers;
• 101 million BTUs of energy—enough energy to power an average American
household for 406 days;
• 12,781 lbs of emissions—carbon sequestered by 153 tree seedlings grown
for 10 years;
• 6,812 lbs. of solid waste—a total of 235 thirty-two gallon garbage cans of
waste.”
This paper publication was produced twice each year up until 2010, when it
became a web-based publication only.

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VALUE CHAINS

DAVID A. COLLIER AND JAMES R. EVANS

2-1 Explain the concept of value and how it can be

A pple has mastered the art of blending physical goods

For example, managers and engineers often work at supplier

What do you think?

Value and Supply Chains

The Concept of Value

• Value is the perception of the benefits

If the value ratio is high, the good or service is perceived

(a) increase perceived benefits while holding price or cost

Value Chain Paradigms and Perspectives

Exhibit 2.1 An Input-Output Perspective of a Value Chain

Exhibit 2.2 Examples of Goods-Producing and Service-Providing Value Chains

Buhrke Industries, Inc. Value Chain

• Buhrke’s objective is to be a customer’s best total-value

Exhibit 2.3 The Value Chain at Buhrke Industries

Source: Buhrke Industries

Buhrke Industries, Inc. Value Chain

Value Chain Paradigms and Perspectives

Exhibit 2.4 Pre- and Post-Service View of the Value Chain

Nestle—A Service View of a Business

Value and Supply Chains

Many organizations use the terms “value chain”

Value and Supply Chains

A value chain views an organization from the

Exhibit 2.4 Pre- and Post-Service View of the Value Chain

Exhibit 2.5 A Value Chain Model of Dell, Inc.

Value Chain Decisions

Value chains may be centralized or

Outsourcing and Vertical Integration

Three Waves of Outsourcing

2. Outsourcing simple service work, such as standard

3. Outsourcing skilled knowledge work, such as

The Economics of Outsourcing

Find the breakeven point: (VC2)Q = (VC1)Q + FC

Solved Problem—In-House versus Outsource

Using Equation 2.1 we obtain:

In this case, because the customer order is for only 12,000

Solution – Excel Model of Outsource Solved Problem

Value chain integration is the process

Value chain integration in manufacturing

Value chain integration in services

Offshoring is the building, acquiring, or

Exhibit 2.7 Things to Consider When Making Offshore Decisions

Value Chains in a Global Business Environment

Challenges Facing Multinational Enterprises

Rocky Brands, Inc.

Rocky Brands, Inc.

Exhibit 2.8 Rocky Brands, Inc. Value Chain

Rocky Brands Global Challenges

Issues for Managing Global Value Chains

• Transportation is more complex in global value chains.

Issues for Managing Global Value Chains

• Global purchasing can be a difficult process to manage

Issues for Managing Global Value Chains

Sustainable Value Chains

Sustainable Value Chains

Bookmaster Case Study

Extra Slide: Save a Tree—and Much More

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