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
external
supplier/
customer
firm
internal
transaction
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 customer’s need
Firm Value Chain (Porter’s Generic Value Chain)
support
activities
Firm Infrastructure
Human Resource Management
Technology Development
Procurement
inputs
R&D
production
marketing
and sales
service
outputs
forward, downstream
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primary activities
backward, upstream
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
firm
value
chain
customers
Linkages between different value chains
Distribution / Marketing Channel: Marketing organizations (individuals,
systems and tools) responsible for the flow of goods and services from
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the producer to the end consumer.
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
external
suppliers
internal
production
system
flow of products,
services and
information
C
u
s
t
o
m
e
r
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
backward
integration
engineering
and design
manufacturing
manufacturing
firm A
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
100%
Forward
PC
Manufacturer
Outside
Manuf.
50%
50%
Outside
Chip
50%
PC
Manufacturer
PC Retail
PC Retail
full backward integration
PC manufacturer buys 100% of
the product utilized and the Chip
Company sells 100% of the
product produced.
partial backward integration
PC manufacturer buys <100% of
the product utilized and the Chip
Company sells <100% of the
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product produced.
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
manufacturing
manufacturer A
manufacturer
B
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
Confrontation
Arm’s Length
Relationship
Acceptance of
Mutual Goals
Full
Partnership
Traditional Relationship
New Relationship
Confrontation
Suspicion
Outsourcing
Cooperation
Trust
Outpartnering
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RELATIONSHIP WITH SUPPLIER
OUTSOURCING
Product (capacity) buys
Reduced direct costs
Expertise
Flexibility
Name recognition
Rationalization
OUTPARTNERING
Process (capability) buys
Access to technical market
information
New technology/processes
Rationalization
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
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processes of the two firms
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
materials, parts,
sub-assemblies
and services
manufacturer
finished goods,
end products
and services
distributor
retailer
package and delivery
customer
satisfaction with
quality,price, delivery
and service 24
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BASIC SUPPLY CHAIN and DOMINANT FLOWS
flow of order and cash
flow of products and services
s
u
p
p
l
i
e
r
physical
supply
manufacturer
distribution
system
c
u
s
t
o
m
e
r
physical distribution
manufacturing
planning and
control
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
business’s 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 manufacturer’s goods, and the manufacturer
who creates the goods
• resellers who sell a manufacturer’s goods, the
manufacturer who makes the goods, and the distributors
who supply the manufacturer’s 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).
i. The SFP is the place in the supply chain where the
supplier allocates the goods ordered by the customer.
ii. 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 customer’s 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.
3. 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 are33
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 customer’s interest, the supplier can benefit if it simultaneously
moves the SFP. By coordinating movements in both the demand and
supply chains, suppliers improve their customer’s 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-Hill’s 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
SUPPLY CHAIN
satisfy and manage demand for
products and services
+
DEMAND
CHAIN
create, develop and sustain demand for
products and services (R&D, marketing,
sales, after sales services, customer
relations, ...)
DEMAND- SUPPLY
CHAIN
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VALUE NETWORKING
suppliers
manufacturers
distributors
retailer s
customer
Value
Strategy
Network
Infrastructure
Logistics &
Operations
suppliers
manufac- distributors
turers
retailers
customers
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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
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are organized to improve network productivity.
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
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goods after receipt of order)
CASE : NIKE
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High End: refers to the best and generally most expensive of a class of goods
or services.
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
Manufacturer
Distributor
Value-Added
Reseller
End User
Suppliers
Corporate
Reseller
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TO DYNAMIC SUPPLY (CHAIN) NETWORKS!
Publisher
Retailer
Manufacturer
Distributor
Value-Added
Reseller
End User
Suppliers
Corporate
Reseller
Financing
Provider
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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.
Buyer-side
Value Chain
vertical
collaboration
Supplier-side
Value Chain
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.
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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.
horizontal
collaboration
Partner 1-side
Value Chain
Partner 2-side
Value Chain
Firms with similar capabilities
and chain activities can learn
from each other more
effectively. Learning from rivals
stimulates innovation and its
diffusion.
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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
accountability,
relationship linkage risks/costs/gain
extended communication
and performance metrics,
incentive realignment
Metric: A standard of measurement of performance
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