THE LINEAR VALUE CHAIN
This page goes deeper into describing the dominant linear production and organisational systems existing today in developed/western countries; with short historical perspectives in the Blog entries at the bottom of the page.
The video above, is one of two videos that provides an overview of the Linear Value Chain. This first video, explains the key elements in the value chain and the micro-economy.
To the right, are tabs that contain more information on each of the main elements, explained in the video.
The video above, is the second of two videos giving an overview of the Linear Value Chain. This video shows the macro-economy. The macro-economy includes the institutions, infrastructures and policies that influence, and in most cases, make possible, the industrial value chain (the micro-economy). Although not discussed in detail here, the macro-economy also includes a state or regions relations - such as trade, finance, and politics - with other states or regions; and the impact and influence that these relationships have both on the rest of the macro-economy and the micro-economy.
To the right, are the tabs that contain more information on each of the main elements, explained in the video; and in the text below, there is further explanation in a more essay form.
Written by Tom Snow
The value chain concept was first described and popularised by Michael Porter (1985). A value chain is "the sequence of productive (i.e., value-added) activities leading to and supporting end use" (Sturgeon 2001); in other words, each actor in the sequence adds value, often in it's own market, and therefore, obtains profits/rents for their work - including particular types of customers. The linear sequence of events can be broken down into five main stages: inputs (extraction), make (production), outputs (goods/services and distribution), consume (use or buy/rent), and waste (throw-away).
Modern value chains are often complex, global supply and demand networks, that are usually initiated by national, trans-national, or multi-national Lead Manufacturing Firms (e.g. Caterpillar Inc.), or Lead Sales Firms (e.g. retailers in the apparel industry like Zara España S.A., or Decathlon Group), or a hybrid of the two (e.g. Apple Inc.); all of which are predominately based in industrialised countries. There are also firms like Cisco Systems, Inc., for example (shown in the map as a 'Service Inputs' firm), which are Lead Firms within their upstream supply chain, but are not a Lead within the downstream of the value chain of the industries they serve. The main focus of the map above is on the Lead Manufacturing Firm, although it can equally be used to describe the other types of Lead Firms.
The word 'chain' in a 'supply or value chain' - creates a mental description (like the photo above) of a linear view of a system.
In ecology, the different predator-prey relationships in an ecosystem can be described as food-chains - a linear view. However, although the concept of food-chains still exists (usually to explain simple interactions, as that one shown above), it has also co-evolved with the more modern concept of 'food-webs,' which describes much better the complex, non-linear, relationships between all the different forms of life in a community. As should become more apparent in the web-pages to follow, value chains are evolving both conceptually and physically from chains to webs (also known as networks and systems).
Inputs: The two main groups
Written by Tom Snow
The Lead Manufacturing Firm has two forms of inputs: A) Factors of Production B) Supply Chain.
In the image above, can you identify the different elements described below, that are required for producing the meal (a product or service)? See the answers at the end of this section.
A) Factors of Production
The first form of inputs, the ‘left leg’ in the main map at the top of the page, are the Factors of Production:
- Land Space
- Entrepreneurship & Management
- Specialised Labour
- Capital Goods & Technology
These inputs are not consumed within the direct process of manufacturing and delivery of the final good. All businesses need all four of these factors of production to create and run a business to provide products and services. It is often asked "where is 'money' - isn't that a minimum factor for a business?" The answer is no: Money is a means of facilitating trade, it is not in itself a productive resource (like all the rest) - you can't use money to hammer in a nail for example; and it is possible to produce services and products without money (i.e., in the commons), but it is not possible without these four factors of production. See more about this in the blue bar to the upper right entitled 'Factors of Production.’
Every company and start-up has to be able to bring these four fundamental elements together to deliver a product or service to it’s customers. And just as start-ups often focus on the minimum viable product, that they can get to the market to start making revenues, here the factors of production also highlights a company’s need to also manage a minimum viable space, minimum viable entrepreneur, minimum viable team and or labour, and minimum viable technology (which can also include a process or ‘recipe’).
B) Supply Chain
The second form of inputs, the 'right leg’ in the main map at the top of the page, is the Supply Chain, which consists of two main subgroups, Raw Materials and Intermediate Goods:
Raw Materials (shown as the green icon):
- Biotic Materials
- Abiotic Materials
Intermediate Goods (the three black icons):
- Transformed Materials
These inputs are consumed during the production and delivery of the final product. This 'leg' is an organised network of contracted, and sub-contracted suppliers (B-to-B companies).
Answer to question at the top of this section: The Land Space is the kitchen, and more specifically can be the kitchen work-surface area; the Entrepreneur & Management and the Specialised Labour can be both of the people - unless one of them is the boss (a professional environment or a teacher for instance); the Capital Goods & Technology is the frying pan, the oven, the cooking hob, knives… and the recipe; the Raw Materials includes the vegetables (biotic), the salt (abiotic), air to breath and to take away odours and steam, and water for boiling, washing, and drinking; the Intermediate Goods are the electricity or gas used to power the cooking and lighting equipment for instance (Energy), the wine (Transformed Materials), and the Components are not so obvious in the photo, but this could include a pasta sauce for instance.
Raw Materials: Where do they come from?
Written by Tom Snow
The material outputs from mining activities are not only inputs for the manufacturing value chain, but are also inputs for hard infrastructure and modern agriculture. And like modern Agriculture, both are also enabled by hard infrastructure, making them very much inter-dependent actors within the economy’s technical foundation. Raw materials are the critical inputs to the value chain: without raw material inputs coming from mining and from AFFF - Agriculture, Forestry, Fishing and Foraging (and in some cases coming via hard infrastructure), modern manufacturing industry grinds to a halt.
Today, industrialised countries increasingly depend on raw materials from countries with high natural (both abiotic and biotic) endowments (U.S, Australia, Argentina, Brazil, African Countries, and Russia for example). According to (Bairoch 1993) in:
“...1973 30% of the commercial energy used by the Western developed countries came from the Third World; for Western Europe this share was as high as 58%”… and …“[i]n the case of some metals the developed Western countries obtained as much as 90% of their supplies from Third World countries.”
Contrary to common opinion, however, this is actually a relatively modern phenomenon. Again according to Bairoch, the developed countries were almost self-sufficient (collectively) in energy, as late as the period after WWII. In 1913, the UK was a net exporter of coal - “6% of world production” (Bairoch, 1993), and it was only after the changes in the Middle East, following WWII, that consumption patterns in energy really shifted. Bairoch also argues that this was a very similar story for all major minerals, except perhaps for textile fibres, though dependency was limited.
The Mining Industry (mainly for metals) consists of three main activities: Mine Production, Smelter Production and Refinery Production. And as with the rest of the supply chain, Mining Industry activities also have a form of hierarchy:
“While mining has moved from developed to emerging economies, smelter and refinery production remains located mainly in developed countries, although this balance has already started to change with the quick growth of Chinese production of refined copper and aluminium.” (ICM October 2012)
In Lester Browns book ‘Plan B 4.0’ (Brown, 2009), he highlights this vastly increased dependence on other countries natural resources, and the changing forms of fixing imports. One of the most extreme being the more affluent countries buying or long-term leasing of large Land Areas in other countries. Examples include Libya:
“After more than a year of negotiations it [Libya] reached an agreement to farm 100,000 hectares (250,000 acres) of land in the Ukraine to grow wheat for its own people. Another example is China firm ZTE International that has secured the rights to 2.8 million hectares… in the Democratic Republic of the Congo on which to produce palm oil…” (Brown, 2009)
...which was used for cooking or biodiesel fuel. Other countries that are also following this strategy are Saudi Arabia, South Korea, Kuwait, India, Egypt, Jordan, the United Arab Emirates and Qatar.
Production: A Vertical Spintering of Industry
Written by Tom Snow
Capital goods suppliers, such as the machining-tool industry, produce industrial equipment such as milling machines, grinders and lathes, that are bought by mass-manufacturing firms. It is the capital goods, combined with particular production technologies, such as interchangeable parts and the production-line system (as-well as organisational innovations) that have transformed production into mass-production. According to (Rosenberg, 1982) most of the technological innovation of the past two centuries have occurred within the capital goods industry.
As Adam Smith explains, in the Wealth of Nations, with his famous example of the pin factory, there has been a continuous, progressive division of labour during and since the industrial revolution. Division of labour is essentially, breaking-down the manufacturing process into its' component parts, and applying machinery (Capital Goods) - mechanisation, and logistical management, to assist in the productivity of each process.
Through the division of labour, there is another dynamic which occurs, which is specialisation. Specialisation increases, as a worker develops greater knowledge of their particular job, as they spend more time doing it. Today, specialisation has evolved from ‘learning by doing and using' within the factory, to also much of the higher-education and vocational training system external to industry; and so now a majority of people entering the workplace have a minimum of specific skills in specific disciplines, such as marketing, accounting, computer literacy, or production management for example.
It is exactly the development in the division of labour and specialisation that has been the underpinning for the development of the modern supply chain. As each process becomes more and more specialised, entrepreneurs have taken the opportunity to specialise in specific parts of an industrial process or good - making metal springs for example; that they can then offer as a product or service as an independent company, to different companies, across different industries, in the case of the metal spring. They can then increase their productivity through ever increasing specialisation and through the introduction of mass-production technologies, and combined with the dynamic returns-to-scale (as they have a larger potential market), these companies can now produce the specific part within the supply chain at a fraction of the cost that the original company could just for itself. This process has spread from intermediate components, to services such as accounting, and IT for example.
This process has been described as:
“…a vertical splintering of industry [leading to] each [sequential] layer produc[ing] an intermediate product which becomes an input to the next stage in the production process.” (Argyrous, 2011).
In essence, there are now a vast array and number of 'vertically specialised' companies that are positioned between the lead company and the raw materials. And it is this trade along the upstream supply chain that dominants international trade, and it is estimated that "about 50 percent of the value of international trade in goods and services is in intermediate rather than in final goods and services" (Milberg et al, 2013).
As manufacturing industries have increased in their 'vertically splintering' during the last 20 years or so, the types of firms and their scope of activity within the value chain has changed.
The 'original' mass-production firm was predominately an Integrated Firm. Now, often referred to as the old style of manufacturing (or even a 'dinosaur'), many of these firms went through a process of selling, spinning-off, or closing, some of their vertical activities (such as component manufacturing divisions and/or subsidiaries, and business services like IT for example), and then, contracting or subcontracting these from suppliers.
These Integrated Firms are then transformed into what is called a Lead Firm, which is described in a moment. Examples of Integrated Firms include “old” Ford Motor Company, “old” IBM Corporation, perhaps still Koninklijke Philips N.V, and (at least in 2011) a Chinese company like BYD Auto Co., Ltd for example, that manufacturers/ed nearly all its own components (Day, 2011). Tesla Energy’s ‘Gigafactory’, a battery factory (cell production estimated for commencement in 2017), is a modern-day example of an integrated firm both in a developed country and in the growing area of electric energy storage (linked to growth - and projected growth - in electric transport, mobile technologies, renewable energies). This latest example actual shows a potential reverse in the trend.
Mass-production firms go through (and in many case, continue to go through) this process, for a few reasons: perhaps the sourced good or service is cheaper and/or higher quality than they can make it themselves, or it is a way to free-up cash for investment it in other things. The way in which these contracted companies can make things cheaper, through specialisation, and economies-of-scale is briefly mentioned above, but this only focuses on the micro level. At the macro level, many of these contracted companies potentially also have access to cheaper input costs (access to a large skilled, or cheap low-skilled, labour force for example - as in China and India for example) and cheaper credit, through a difference in domestic laws and norms, and government policy (including, in some cases exchange rates). And this is, in part, made possible by the revolutions in the internet and digital communications, supporting the management of downstream supply chain logistics and the monitoring of inventory for instance; and a global financial system with global financial standards.
This mass-production 'group' of actors are now vertically integrated and specialised in the value chain. And the head of the downstream supply chain, like the Integrated Firm, is the Lead Firm. Also similar to Integrated Firms, Lead Firms also initiate the flow of resources and information through the value chain with the direction of production, and marketing of final goods. They differ, however, from Integrated Firms in that they focus on their ‘core competences’ and 'high value added functions', such as branding, marketing, finance, product strategy and definition, design, assembly of sourced components, and even sales (like Apple Inc. and Dell Inc. for example). And in some cases like Dell, these lead firms have become FABless - they do virtually no manufacturing or assembling themselves anymore.
Increasingly, over the last 10 years, many lead firms have consolidated this vast base of sourced intermediate good suppliers, with examples of lead firms reducing supplier numbers from a thousand to a few hundred (Harrison 2008). In this situation, the old suppliers (i.e. component manufacturers) often remain in the value chain, but now they are contracted via a new group of specialised firms called Turn-key Suppliers, examples include Dana, Delphi, Celestica, and Foxconn; huge companies, relatively unheard of by final consumers/users. And these Suppliers are in some cases ‘single-source’ strategies, in the case of Foxconn, that are contracted by Apple Inc, to assembly it's iPhone. In this example, Foxconn manages all the logistics of the downstream supply chain for the iPhone (Milberg, 2013).
Below the Turn-Key Supplier in the map, are the intermediate goods manufacturers. Again, this often has some hierarchal structure, as component manufacturers have in many cases, also 'vertically splintered', and outsourced parts of the production process can be contracted somewhere else cheaper. And so this hierarchy often goes down, to the companies that are producing the simplest 'widget', at the cheapest possible price. Important to note that the bottom of this hierarchy is, unsurprisingly, predominantly manufacturers in developing countries.
Private and State-Owned Enterprises
Written by Tom Snow
After the Second World War, many European governments transformed particular enterprises into state-owned enterprises (SOEs) or created new ones (with complete or partial ownership), making them, by far, the largest single employer in the domestic economy. These state-owned enterprises make up a large part of the modern-day hard and soft infrastructure, and are often formed where there are natural monopolies, or where the enterprises are politically sensitive or strategic.
Natural resource extraction, energy production and/or distribution, transport networks, the military, broadcasting, and healthcare are just some of the typical examples of SOEs within infrastructure. These government activities also extend, in some cases, into the value chain, with full or partial state ownership of strategic industries - such as automobile companies ('Integrated Firms' or 'Lead Firms'), and steel works (‘Chemical & Material Suppliers'): - Strategic in the sense that the goods and technologies produced from these sectors can bring many accumulative benefits across industry as a whole, and/or potential payback may be too long or too risky for the private sector to take the initiative for instance.
In other cases, government often bears financial responsibility in some enterprises that are classed as 'public goods' (i.e., lighthouses, flood defences, bridges, roads, and emergency services); in-which the usage/access can not be restricted just to those people who have paid for it (i.e., blocking the light from the lighthouse for those who didn't pay and contribute to its construction and running costs), and so for a private enterprise, it can be difficult to finance. Here, government's normally tax (socialise the cost to) all users (generally everyone in the economy), and use the income to provide the service or pay someone else to provide it.
Transport or communications SOEs and public good SOEs, in particular (i.e., roads, high-speed Internet...), can both increase productivity of industry, increase public services, and create jobs during construction and through their management. Except for the majority of public goods, these enterprises, briefly mentioned above, can be state-owned or run privately; it is really a political choice; hence the many difference stances taken by countries, states, political parties, academics and the public.
Written by Tom Snow
Governments and Regions have access to many tools that they can use to influence (i.e., provoke, support or restrict) certain developments in the economy. This section focuses on a few of the key ones. This is a slightly more technical section, aimed more at policy or economic development actors.
Principles, Standards & Guidelines (Some Rules)
This is a very powerful motivator and regulator of markets: dictating what can and can't be sold in a particular market, and in many cases it can dictate much of the products design (material selection, size, weight, volume, power consumption, and pollution levels in its production, use and waste, for example), which is linked to its unit cost, and its distribution cost in foreign markets for example.
Principles, Standards and Guidelines can be used to protect domestic markets (and consumers), as some countries have different standards in different areas of the economy. Finally, how products and the processes within different stages of the supply chain are classified can strongly influence the economics of different business models and forms of value creation. Many institutions helping to develop changes to the environmental impact of industry, work hard in this area; from setting up groups in Brussels to help lobby to ‘change the rules’; or the education and development of tools for eco-design and ISO quality standards for instance.
Economic Industrial Policy
Governments and their economic agencies can influence strategic actions within industry through the coordination of different policies, to deliberately catalyse private-sector growth. These policies can help industry, mainly, in their access to the 'factors-of-production' and in productivity. How this is done, and where the starting line is drawn and projected from, is where varying economic schools of thought differ.
Parks and Zones
This includes two, sometimes linked, industrial development strategies.
Industrial Parks (IE). Also known as industrial estates or trading estates, are zones that have been planned for the development of industry. The parks can reduce hard infrastructure costs, borne by the individual businesses, such as internet and high-power electricity supply for example. Site 'symbiosis' can be possible, in the case that some business are customers for other businesses in the park - reducing logistics costs for example. And industrial parks can be easier to manage environmental controls of one large site, rather than many individual industries spread across a large area.
Special Economic zones (SEZ). Also includes (FTZ), EPZ (Export Processing Zones), FZ/FEZ or BLP for example. Within these designated zones, typical incentives (Milberg, 2013) can include exemption or reduction in some of the following: import duties on raw materials and/or intermediate goods, export taxes, local and property taxes, VAT on domestic purchases, provision of streamlined administrative services - particularly for imports and exports, and enhanced hard infrastructure for example. Soft infrastructure benefits can include (controversially) reduced labour rights and standards, and different regulations for leasing or purchasing land for example. SEZs can apply to a single factory, a “fenced-in” geographic area, or an entire province.
SEZs are generally created to attract foreign firms in the case that certain local industries are not able to export (to be internationally competitive), and so to generate foreign exchange. For some governments intent to promote exports and create jobs, and foreign firms such as TNCs (Trans-National Companies) looking for financially viable production conditions, SEZs have seemed to reconcile these two objectives. For SEZ’s to contribute to sustained domestic economic development, they need linkages with the rest of the economy - which by their very nature is not a given, and so focus must be given.
Within the soft infrastructure, and directly acting and influencing the way in which the value chain forms and develops are ‘Action Groups.’ This includes groups, or a network of groups and individuals, involved and tasked in the activity of change on some part of the system as a whole. It is important to highlight this group specifically from the other institutions and groups (although inter-dependent), as this group is often made up of a mix of different types of stake-holders from different parts of the ecosystem. The responsible(s) of these groups are often tasked with the facilitation of the actors themselves: structuring the meetings, sharing knowledge, being a broker-of-trust, developing the network of stakeholders involved; facilitating the development of research and strategy; and implementing directly or indirectly, in the system - either as policy proposal, or as a real project within a company for example.
Michael Porter popularised different sources of 'competitive advantage,’ and one of those being 'industrial clusters' (see the 'soft infrastructure' tab). Clusters are an important form of action group. Clusters are "an alternative way of organizing the value chain... A cluster of independent and informally linked companies and institutions represents a robust organisational form that offers advantages in efficiency, effectiveness, and flexibility.” (Porter, 1998). Porter (1998) also uses an example based on a wood product cluster, which showed that "[s]ubstantial improvement in productivity was possible, but only if several parts of the cluster changed simultaneously." Highlighting that clusters can also be useful tools in facilitating changes across an entire value chain level.