Operations Management/Ch.

2 Value Chains in Global Operations

2007 Thomson South-Western
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Value Chains in Global
Operations
CHAPTER 2
JAMES R. EVANS
AND
DAVID A. COLLIER
OPERATIONS
MANAGEMENT
An Integrated Goods and Services
Approach
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Chapter 2 Learning Objectives
1. To define value and three ways to increase
it, to describe a value chain using input-
output or pre- or post service diagrams, and
to distinguish between a value chain and
supply chain.

2. To describe the role of operations, vertical
integration, and outsourcing in designing
and managing value chains, and to apply
break-even analysis to simple outsourcing
decisions.
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Chapter 2 Learning Objectives
3. To describe the nature of a multinational
enterprise and value chains in a global
environment, to explain the advantages
and disadvantages of off shoring
decisions, to identify difficulties associated
with managing global value chains, and to
recognize the role of local culture in
managing nondomestic operations.
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Chapter 2 Value Chains in Global Operations


Given the chapters three lead in discussions
What is your opinion of companies that move
operations to other countries with cheaper labor
rates?
In the long run, do you think that such decisions
help or hurt business competitiveness and national
economies?
Should governments influence or legislate such
decisions?
You might want to discuss Question # 22 on page
66!
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Chapter 2 Value Chains in Global Operations


Value and Supply Chains

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.
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Chapter 2 Value Chains in Global Operations


Value and Supply Chains

The decision to purchase a good or service
or a customer benefit package is based on
an assessment by the customer of the
perceived benefits in relation to its price.

The customer's cumulative judgment of the
perceived benefits leads to either satisfaction
or dissatisfaction.
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Chapter 2 Value Chains in Global Operations


One of the simplest functional forms of value is:

Value = Perceived benefits/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.
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Chapter 2 Value Chains in Global Operations


Value 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 customer.

A value chain is a cradle-to-grave model of
the operations function (see Exhibit 2.1).
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Value Chains

The value chain begins with suppliers.
Suppliers might be distributors, employment
agencies, dealers, financing and leasing
agents, information and Internet companies,
field maintenance and repair services,
architectural and engineering design firms,
and contractors, as well as manufacturers of
materials and components.
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Exhibit 2.1 The Value Chain
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Value Chains
The inputs suppliers provide might be
physical goods such as
automobile engines or microprocessors
provided to an assembly plant;
meat, fish, and vegetables provided to a
restaurant;
trained employees provided to
organizations by universities and
technical schools; or
information such as computer
specifications or a medical diagnosis.
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Value Chains

Inputs are transformed into value-added
goods and services through processes or
networks of work activities, which are
supported by such resources as land,
labor, money, and information.

The value chain outputs goods and
services are delivered or provided to
customers and targeted market segments.
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Exhibit 2.2 Examples of Goods-Producing and
Service-Providing Value Chains (slide 1)
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Exhibit 2.2 Examples of Goods-Producing and
Service-Providing Value Chains (slide 2)
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Exhibit 2.3 Pre- and Postservice View of the Value Chain
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Pre- and Post-service Value Chain Example
Ford Motor Company found that the total value of
owning a Ford vehicle averaged across all market
segments for service and the vehicle was allocated
according to a customer survey as follows:
the vehicle (i.e., product features and
performance) itself accounted for 52 percent of
total value,
the sales process for 21 percent, and
the maintenance and repair service processes
for 27 percent.
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A Service View of a Business

Nestle once defined its business from a physical good
viewpoint as "selling coffee machines." Using
service management thinking they redefined their
business from a service perspective where the coffee
machine is more of a peripheral good.

They decided to lease coffee machines and provide
daily replenishment of the coffee and maintenance of
the machine for a contracted service fee. This
"primary leasing service" was offered to organizations
that sold more than 50 cups of coffee per day.
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A Service View of a Business

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.
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Buhrke Industries, In. 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 objective is to be a customers 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.
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Exhibit 2.4 The Value Chain at Buhrke Industries
Source: Buhrke Industries company web site
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Buhrke Industries, In. 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.
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Value and Supply Chains

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.
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Value and Supply Chains

A value chain is broader in scope than a supply
chain, and encompasses all pre- and post-
production 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.
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Exhibit 2.3 Pre- and Postservice View of the Value Chain
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Procter & Gambles Supply Chain Structure

A model of a supply chain developed by Procter & Gamble.
P&Gs Ultimate Supply System is shown in Exhibit 2.5.

The supply chain focus is on understanding the impact of
tightly coupling supply chain partners to integrate
information, physical material and product flow, and financial
activities to increase sales, reduce costs, increase cash flow,
and provide the right product at the right time at the right
price to customers.

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Exhibit 2.5 Procter & Gambles Conceptual Model of a
Supply Chain for Paper Products
Source: Wegryn, Glenn W., and Siprelle, Andrew J.,
Combined Use of Optimization and Simulation Technologies to design an Optional Logistics Network,
http://www.simulationdynamics.com/PDFs/Papers/CLM%20P&G%Opt&Sim.pdf
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Value Chain Design and Management

Vertical integration refers to the process of
acquiring and consolidating elements of a value
chain to achieve more control.

Outsourcing is the process of having suppliers
provide goods and services that were
previously provided internally.
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Value Chain Design and Management

Outsourcing is the opposite of vertical
integration in the sense that the organization is
shedding (not acquiring) a part of its
organization.

Offshoring is the building, acquiring, or moving
of process capabilities from a domestic location
to another country location while maintaining
ownership and control.
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Exhibit 2.7 Four Degrees of Offshoring Scenarios
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Value Chain Design and Management

Backward integration refers to acquiring
capabilities at the front-end of the supply
chain (for instance, suppliers), while forward
integration refers to acquiring capabilities
toward the back-end of the supply chain (for
instance, distribution or even customers).

Companies must decide whether to integrate
backward (acquiring suppliers) or forward
(acquiring distributors), or both.

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The U.S. has experienced three waves of outsourcing:

The first wave involved the exodus of goods-
producing jobs from the U.S. in many industries
several decades ago. Gibson Guitars, for example,
produces its Epiphone line in Korea.

The second wave involved simple service work
such as standard credit card processing, billing and
other forms of transaction processing, keying
information into computers, and writing simple
software programs. Accenture, for example, does
much of its bookkeeping operations in Costa Rica.
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The U.S. has experienced three waves of outsourcing:

The third, and current wave, involves skilled
knowledge work such as engineering design,
graphic artists, architectural plans, call center
customer service representatives, and computer
chip design. For example, Massachusetts General
Hospital uses radiologists located in Bangalore,
India to interpret CT scans.
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Letters of Credit Processes Help Make Value Chains Work

The flow of information is an important aspect of value chain design.
Information must move as fast or faster than the physical goods. For
example, global buyers and sellers depend on a "letter of credit" to settle
their payments. The paper-based process used for about four centuries
requires banks to coordinate with one another and exchange documents,
often across oceans, and has numerous drawbacks:

The cost of processing trade documentation is more than 5% of the
total annual value of world trade.
Banks reject half of all "letters of credit" transactions because of
incorrect information from the buyer or seller.
The cost of processing a simple global transaction is about $400.
Each transaction requires up to 24 forms to be accurately completed.
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Letters of Credit Processes Help Make Value Chains Work

Internet-based platforms are leading to vast improvements in letter
of credit value chains.

TradeCard Inc., for example, allows the buyer to connect the flow of
physical goods and the flow of electronic funds and trade documents.

Hi-Tec Sports USA, a California-based hiking shoe company, had to
issue a purchase order to one of its global suppliers in China and
then open a letter of credit with its bank. The process that could take
as much as two weeks.

Today, Hi-Tec uses TradeCard's system and the entire electronic
process seldom takes more than one day. Hi-Tec figures they save
20 cents per shoe by doing an electronic letter of credit.

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Rocky Shoes & Boots Company

Rocky Shoes & Boots (RS&B-www.rockyboots.com)
headquartered in Nelsonville, Ohio, manufactures
rugged leather shoes for hiking and camping.

RS&B 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 Shoes & Boots 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.
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Exhibit 2.6 Rocky Shoes & Boots Value Chain
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Rocky Shoes & Boots Company

The principal characteristics of this global value chain
are described as follows:

Leather is produced in Australia and then shipped to the Dominican
Republic.
1. Outsoles are purchased in China and shipped to Puerto Rico.
2. Gor-Tex fabric waterproofing materials is made in the United States.
3. Shoe uppers are cut and stitched in the Dominican Republic, and
then shipped to Puerto Rico.
4. Final shoe assembly is done at the Puerto Rico factory.
5. The finished boots are packed and shipped to the warehouse in
Nelsonville, Ohio.
6. Customer orders a filed and shipped to individual stores and contract
customers from Nelsonville.
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Exhibit 2.6 Rocky Shoes & Boots Value Chain
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Rocky Shoes & Boots Company Global Challenges

Rocky 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.
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Rocky Shoes & Boots Company Global Challenges

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 RS&B said, "We've
got to get there, or we're not going to be able to
compete."
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Offshoring is the building, acquiring, or moving of
Process capabilities from a domestic location to
another country location while maintaining
ownership and control. According to one
framework, foreign factories can be classified into
one of six categories:

1. Offshore factories established to gain access to
low wages and other ways to reduce costs such as
avoiding trade tariffs. An offshore factory is the
way most multinational firms begin their venture
into global markets and value chains.
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According to one framework, foreign factories can
Be classified into one of six categories:

2. Outpost factories established primarily to gain
access to local employee skills and knowledge.
Such skills and knowledge might include software
programming or call center service management.

3. Server factories established to supply specific
national or regional markets.
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According to one framework, foreign factories can
Be classified into one of six categories:
4. Source factories, like offshore factories,
established to gain access to low cost production
but also have the expertise to design and produce a
component part for the company's global value
chain.
5. Contributor factories established to serve a local
market and conduct activities like product design
and customization. Primary manufacturing,
accounting, engineering design, and marketing and
sales processes often reside at contributor factories.
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According to one framework, foreign factories
can be classified into one of six categories:

6. Lead factories established to innovate
and create new processes, products, and
technologies. Lead factories must have the
skills and knowledge to design and
manufacturer "the next generation of
products."

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James Womack, the co-author of "The Machine that
Changes the World," states that

"Outsourcing production, in whole or part, makes the
most sense if a manufactured product is stable, requires
lots of labor, and doesn't need lots of technical
support."
He recommends a product-by-product analysis to
determine what production is appropriate to move where
instead of the argument that if everyone else is going to
China, we should go.

Wall Street Journal, October 6, 2004, p. B 1.
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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.
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Value chain integration in services where value is in
the form of low prices, convenience, and access to special
time-sensitive deals and travel packages takes many
forms. Examples include:
Third party integrators for the leisure and travel industry
value chains include Orbitz, Expedia, Priceline, and
Travelocity.
Many financial services use information networks provided
by third party information technology integrators such as
AT&T, Sprint, IBM, and Verizon to coordinate their value
chains.
Hospitals also use third party integrators for both their
information and physical goods such as managing patient
billing and hospital inventories.
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Exhibit 2.8 Comparison of Work Forces in
the United States, India, and China
Source: OSullivan, K., and Durfee, D., Offshoring by the Numbers, CFO Magazine, June 2004, p. 54.
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Exhibit 2.9 Example Issues to Consider
When Making Offshore Decisions
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Exhibit 2.10 Offshore Candidates for Service
and Information Work Activity
Source: Harris, R., Offshoring by the Numbers, CFO Magazine, June 2004, p. 58
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Example of Offshoring Risk
Protecting Intellectual Property



Schwinn Bicycle Company entered into a contract
manufacturing agreement with one Taiwan manufacturing
company.
Within a decade, the Taiwan Company became Giant
Manufacturing (www.giant-bicycle.com) and broke its
supplier relationship with Schwinn.
Giant started producing its own bicycle brand name and
has opened up it's own U.S. subsidiary in the U.S.
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Exhibit 2.11 Example Advantages and Disadvantages of
Global Offshoring and Outsourcing
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Exhibit 2.12 Example Countries Participating in
Global Supply Chain Development
Source: Datz, T. Outsourcing World Tour, CIO Magazine, July 15, 2004, pp. 4256
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Complex global value chains are more difficult to
manage than small domestic value chains. Some
of the many issues include the following:

Global supply 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.
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Some of the many issues include the following:
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.
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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.
Privatizing companies and property is another form
of major changes in global trade and regulatory
issues.
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Exhibit 2.13 Example Cultural Differences that Impact
Business
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Solved Problem #1 Outsourcing & Breakeven Analysis

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?
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Solved Problem #1 Outsourcing and Breakeven Analysis

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 only for
12,000 units, which is less than the break-even point,
the least cost decision is to outsource the component.
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