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    The Value Chain Revolution


    © International Trade Centre, International Trade Forum - Issue 1/2004

    The bank can learn from the pizza parlour - high-quality customer service in one sector leads consumers to expect the same level of service in other fields.

    A revolution is looming in the world of goods and services procurement. It will fundamentally change the relationships between costs and returns.

    Most companies, even small ones, understand the supply chain challenge. They realize that they must arrange for supplies to arrive when they need them, process their products as efficiently as possible and arrange for their delivery when they are demanded.

    But the simple outline of the supply chain equation disguises what is changing. Many bookstores these days no longer have to keep a large inventory of literature. They can meet their needs by ordering through the same Internet supplier as most of the consumer world. They no longer need close relations with distributors and publishers. What the big bookstores need, today, is a wide display of all the works on offer. People still like to browse. And holding one copy of an interesting book is within reach of a small bookstore - especially if it is returnable to the publisher.

    It may look like just another, new and interesting supply chain diagram. In fact, this is a new business paradigm. Companies no longer flourish solely on the size of the inventory they can afford to carry. They compete on price and inventory. But their survival depends on how they can exploit the value chain. And part of that value chain is knowledge of the customer.

    The bank can learn from the pizza parlour

    Professor Yossi Sheffi, Director of the Center for Transportation and Logistics of the Massachusetts Institute of Technology, United States of America (USA), can call his local store in Boston and immediately be welcomed by name and asked whether he wants to order a pizza. The store clerk will even suggest the professor might want to order the same as last time.

    All this is a result of the store recognizing his telephone number and calling up the details on its database. When Prof. Sheffi calls his bank to carry out a transaction, though, he reports that: "I have to go through about 17 people who do not know me or what I want."

    As it happens, his bank manager lives in the same building. Prof. Sheffi once tackled this senior financial officer to ask why banks make it so difficult for customers to do business with them. The bank manager's response: "No other bank does it better."

    Sheffi's reaction as a business executive was: "That is irrelevant. My expectations have been formed by my grocery store." The cross-sectoral impact of such demands created by the level of service offered by the most technologically savvy providers will fundamentally change all consumer fields, he expects.

    Competing on home ground

    This is not just a story for the industrial world. As one Middle East producer pointed out, though his company is committed to "just-in-time" delivery: "Just in time in our part of the world can be two and a half months." The important factor is that his firm can beat the multinationals in reliability of supplies and deliveries, and is thriving. It is able to satisfy local standards better than outsiders. Boston expectations are not those his company has to meet, just the demands on home ground.

    But one principle stretches across all forms of trade in an increasingly globalized economy. Local firms have to do better than outsiders on price or flexibility. One business leader describes it as a recipe for disaster if a firm fails to compete on either of these elements.

    But how to achieve such flexibility or price attractiveness? A. Michael Spence, Philip H. Knight Professor Emeritus at Stanford Graduate School of Business, USA, argues that companies that cannot compete with big suppliers on economies of scale have to use the best technology if they want to improve their flexibility and stay in business.

    Faster turnover

    Thanks to digital developments this need not be simply an opportunity for large firms. Gregory J. Owens, Chairman and Chief Executive Officer of Manugistics Group, USA, notes that stock control - which is now common in computerized companies - would be impossible with only a traditional pencil and paper. Even ten years ago, it was rare for inventory to turn over three times in a year. Today average sales are ten times inventory. For companies in the 1990s, the level for survival was probably to reduce inventory to one-fifth of the year's delivery. Unless they could institute the controls to achieve such levels, they went out of business, he observed.

    One of the benefits of computerized stock control - and the Web has made such control instantaneous - is that as well as tracking customer orders, companies can also use the increased power over deliveries to manage supplies for the best returns. They can plan deliveries in a way that will keep up prices or bring in revenues as needed. Once again, it is not just a question of supply but of value.

    All along the supply chain, globalization has put pressure on firms to be more efficient. The trend is for longer delivery chains, more complex demands, more sophisticated products. All these developments in the production process push up costs - costs that cannot be passed on to purchasers.

    Finding the value

    Profits are therefore squeezed, unless companies can demonstrate global flexibility. According to Henner Klein, Managing Officer of A.T. Kearney, Belgium, who spent several years at the head of industry before taking over the Belgian branch of the consultancy firm, this trend puts the emphasis on finding where the value lies in the supply chain and maximizing returns from these sections, because costs can no longer be simply pushed downstream or upstream.

    For Barbara Kux, Chief Procurement Officer of Royal Philips Electronics, the Netherlands, even the term "supply chain" is now outmoded, as is talking about "costs" and "suppliers". If companies are to respond to market demands faster, better and cheaper, they have to take an integrated view, optimizing the value chain in the same way a major computer manufacturer has done.

    It started with an unconventional idea at the time. The company founder, still a student, started his business by enabling would-be buyers to telephone sales staff and buy a made-to-order computer instead of forcing them to accept an off-the-shelf product from the retail store. From that time, the company has maintained its focus on the value chain, moving on to sales via the Internet, extended warranties using courier services, and now offering peripherals: each step has incorporated links in the supply chain from which it can derive more value than through allowing the business to go to another company. The company has challenged the personal computer industry by getting the best returns possible from combining all aspects of purchase from design to replacement. Yet its computers and equipment are still not sold in the shops, one indication of its original approach to the challenge of marketing and revenue-earning.

    Value chain driven development puts procurement officers in a new and powerful position, more and more at the centre of innovation. Kux is convinced that: "We will be the key function of generating shareholder value in this century."

    Technology to the forefront

    Technology therefore comes even more to the forefront of value management. And latest developments give hope even to small firms that they can compete against the big players if they get their "value chain" (product, delivery, marketing and market) right.

    One of the major technological transformations comes in the shape of a plastic strip less than ten centimetres long. The RFID (radio-frequency identification) tag could track every atom on earth, if anyone should want to, notes Stav Prodromou, Chief Executive Officer of Alien Technology, USA, whose firm manufactures RFID tags. What RFID can do is pinpoint the position of an item no matter where it is in the world. Originally developed during the Second World War to identify whether aircraft belonged to friend or foe, the system, scaled down to fit on to the finger-length strip that looks much like a first-aid plaster, is now being adopted by the US Department of Defense, the retailers Wal-Mart and Tesco (in the United Kingdom and United States), Metro (France) and Carrefour (France).

    RFID's advantage over the barcode is that a product does not have to be manually scanned - and at an average of two seconds per scan, though this might not seem much individually, for a courier company that handles 40 to 50 million packages a day, each one scanned 40 to 50 times, there will be a tremendous saving of time and labour costs, Prodromou observes. He suggests that exporters and distributors might want to track their stocks at the crate level if not the individual product.

    The global corner store

    The essential point for developing countries is that the value chain revolution will not bring benefits just to multinationals and major players in industry sectors. Computerization and second-by-second monitoring mean that even the corner grocery store can provide better service than the local bank. However, this does not mean that the developing country supplier has to meet Boston standards of service. Nevertheless, the closer globalization brings the world to the local economy, the more important the logistical and structural differences between local and global companies will be for competitiveness. Professor Spence is struck by the disparity in expenditure required for transporting goods in the industrialized world compared to developing countries: an estimated average of 8.5% of the costs in the North, while in the developing world it can be twice as much.

    It already makes some developing country exporters less competitive, Spence remarks. Part of the cost comes from infrastructure, but part also from low expenditure on technology, he suggests. For companies that fail to take on board e-management, the price can be high, even for firms in developing and transition economies that are now able to survive.

    ITC applies value chain concepts to develop trade

    • ITC has developed TradeWORKS, a package of information and training materials and technical assistance, to help developing country businesses benefit from the value chain revolution. Working together, firms, business service providers and government agencies develop and implement trade strategies that respond to market requirements.

    Contact Ian Sayers, ITC Senior Adviser for the Private Sector, at sayers@intracen.org or go to http://www.intracen.org/ipsms/tsd for more information.

    • ITC's Executive Forum has produced a national export strategy template on CD-ROM, combined with national training, to improve national export competitiveness. It contains a value chaincomponent.  Contact: execforum@intracen.org

    • Exporting Automotive Components, a recent ITC publication, captures trends in the sector's global supply chain. It provides an overview of how issues such as e-commerce and intellectual property rights are shaping changes in buyer-supplier relations, as well as contacts and information leads.

    Contact Hema Menon, ITC Associate Adviser on Enterprise Competitiveness, at menon@intracen.org

    Related Forum articles

    • Value Chain Analysis: A Strategy to Increase Export Earnings

    • Putting It All Together: ITC's Template for Strategy-makers
    • Putting "E" to Work
    • Negotiating Technology Licensing Agreements

    Find these articles and more on the Forum web site (http://www.tradeforum.org).

    Prema de Sousa, Forum's Contributing Editor, wrote this box.

    Peter Hulm is Contributing Edtior for this issue of Forum.