Introduction

• This paper reports a disguised field study in

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 Strategic Power of the Value Chain:
The Basics
• Whether a firm can develop and sustain
differentiation and/or cost advantage
depends basically on the configuration of its
value chain relative to the value chain
configuration of its competitors
• Value chain analysis is essential to determine
exactly where in the firm’s segment of the
chain (from design to distribution) customer
value can be enhanced or costs lowered

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 Strategic Power of the Value Chain:
The Basics
• The center column of Exhibit 1 (p. 181)
presents a conceptual value chain for the
paper industry
• It is possible to quantify the economic value
created at each stage by identifying the costs,
revenues, and assets for each activity

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 Strategic Power of the Value Chain:
The Basics
• The authors argue that every hypothetical
firm shown on the left or right side in Exhibit 1
(A, B, C, D, E, F, and G) must construct a value
chain for the total paper industry, breaking
the total value in the chain into its
fundamental sources of economic value
• Such an analysis has potential strategic
implications for every competitor in each
segment of this industry

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 Strategic Power of the Value Chain:
The Basics
• Calculation Difficulties
• There are several problems to confront when constructing a
value chain for a firm:
– Calculating a value for intermediate products,
– Isolating key cost drivers,
– Identifying linkages across activities, and
– Computing supplier and customer margins
• However, the authors argue that every firm should attempt to
estimate its value chain

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 Strategic Power of the Value Chain:
The Basics
• Calculation Difficulties (Continued)
• The authors find value chain analysis invaluable to managers
by forcing them to carefully evaluate how their activities add
value to the chain of customers who use their product (or
service)
• The authors present a case study (pp. 184-190) from their
field research (the name of the company and the financial
data are disguised: Northam Packaging Company) which they
believe illustrates the strategic power of a value chain
analysis

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 Northam Packaging Company
• The Business Setting
• Northam Packaging Company produced 206,000 tons of
coated paperboard in 1989
• This paperboard was sold to consumer product firms
(processors) who formed the paperboard into cartons, then
filled and sealed them for shipment to retail outlets
• Northam served two market segments:
– Customer Segment 1: Commodity Processor
– Customer Segment 2: Differentiated Processor

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 Customer Segment 1 (Commodity
Processor)
• In 1989, 146,000 tons of the company’s output went to
“commodity” product firms. For these firms, price is the
major purchase characteristic
• Northam had 40% market share in this segment
• These processors' products were considered commodities
because they did not have an ability to achieve a price
premium for the brand name
• These processors were typically smaller in size
• Northam sold to over 300 customers in this segment
• Overall sales in this segment had declined 3% per year over
the last five years, but stabilized in 1989

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 Customer Segment 2 (Differentiated
Processor)
• Northam sold 60,000 tons of paperboard in 1989 to the second
customer segment, which was high quality, differentiated
processors for whom the carton was an important element of the
marketing strategy
• Northam had a 15% market share in this segment
• These processors were typically larger in size
• Northam sold to only six customers in this segment
• This segment was growing at around 10% pa, and was projected to
grow even faster in the future
• Northam's market share in this segment had declined over time
(Customers attributed the decline to the company’s inability to
consistently produce high quality board)

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 Northam’s Major Process Flow (pp.
186-189)
• Step 1: Paperboard manufacturing (the mill)
• Step 2: Adding the plastic coating (extrusion)
• Step 3: Carton conversion
• Step 4: The filling plants (processors of
consumer products)
• Step 5: The retailer (the supermarkets)

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 Strategic Options
• Which market segment should Northam
emphasize?
• Where should it invest capital dollars?
• The strategic positioning and capital spending
decisions facing Northam (as of 1989) would
shape its future for many years to come!

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 Strategic Options
• On the choice of market segments, Northam
considered two specific alternatives:
1. It could continue to emphasize the commodity
processors whose total market had been declining
3% pa, but who had always been their main
customers; or
2. It could try to aggressively build market share with
differentiated processors whose market was growing
at 10% or more and who would pay top dollar for
board, but who demanded a consistent high quality

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 Strategic Options
• The company’s 15% market share in the differentiated
segment reflected their status as largely a "backup" supplier
• Major capital investments totalling $61.5m had to be made If
Northam was serious about rebuilding market share in this
fast growing segment
• Three new capital investments would be:
1. $43m to upgrade its primary manufacturing facility to improve
board strength, printability. and smoothness
2. $17m to add a new extruder to compete in multilayered
polymer coating applications
3. $1.5m to purchase a printing press

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 Conventional Analysis of the Strategic
Options
• Based on DCF Analysis (see Exhibit 3 on p. 190), this yielded a
13% internal rate of return (IRR), indicating a strong argument
for building market share in the differentiated segment
• Based on a simple 2x2 BCG growth share matrix (see Exhibit 4
on p. 191), this showed that Northam had a low market share
in a high market growth segment (i.e. differentiated
segment), so the strategic inference here would be that it
should aggressively “build” market share in this segment by
making the $61.5 million in new investments

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 Strategic Analysis - A Value Chain
Perspective
• Recapping, the methodology the authors used
in establishing the value chain was as follows:
– Identify value chain stages
– Identify strategic options
– Assign costs and revenues to value chain stages
– Estimate market value transfer prices
– Estimate asset investment
– Calculation accuracy (need to be as precise as
possible)

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 New Insights?
• Exhibit 6 (p. 193):
• Northam’s Return on Assets (ROAs) in the commodity segment is
2% at the mill, 15% at the extruder, and 32% at the converter.
• On the other hand, in the differentiated segment, the ROAs
• are 2%, 15%, and 15% for the mill, extruder, and converter,
respectively
• This further reinforces the unattractiveness of the differentiated
segment

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 New Insights?
• Why invest over $60 million to build market share in the
differentiated segment where Northam is currently able to
extract only 2% of the total value created in the chain?
– This insight is not apparent in the BCG-type strategic analysis or
in a conventional management accounting approach relying on
DCF based project returns
• In fact, the value chain analysis calls into question the sales
volume and selling price assumptions used in the DCF analysis
contained in Exhibit 3

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 New Insights?
• Overall, the value chain perspective yields a
much different picture of this industry:
– It appears to be an industry where the closer one
gets to the end-use customer and the more one
creates product differentiation, the more money
will be made (Exhibit 7)
– But, Northam seems to lose on both counts!
• They lack the ability to forward integrate into the
processor and supermarket segments

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 New Insights?
• Northam (instead of de-emphasizing the commodity segment
as would be recommended by the BCG-type analysis), needs
to find ways to effectively compete in the commodity
segment by being the low cost producer
• Here again, the value chain framework can provide important
insights!
• Northam needs to understand the structural and executional
drivers of cost behavior for the major cost items in the mill,
extruder and converter operations
• Northam then needs to manage these drivers better than its
competitors

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 New Insights?
• Staying in the commodity segment is the only logical choice
for Northam:
– The attractiveness of this option is further enhanced by possible
significant growth in commodity carton demand in export
markets
– Their manufacturing system is geared to this market, and their
reputation has been made in this market
– They also have a low investment base to support this business
as most of the plant and equipment were bought before 1970.
Major new investments are not required to compete here

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 New Insights?
• Looking at the economics of the mill, extruder,
and converting operations, Northam is currently
destroying value (rather than creating value) by
selling in the differentiated segment
• Also, the profitability at the mill is well below
satisfactory levels
• A cost driver analysis at the mill and extruder
stages might go a long way in identifying profit
improvement opportunities
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 Conclusion
• The value chain need not be just an abstract conceptual tool,
it can become a powerful tool of empirical analysis
• The value chain analysis in this paper yields insights which are
much different from those suggested by more conventional
analytic tools
– A summary of the key differences between value chain and
traditional management accounting perspectives is shown in
Exhibit 8 (p. 196)
• Since virtually no two firms compete in exactly the same set
of value activities, value chain analysis is a critical first step in
understanding how a firm is positioned in its industry

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 Conclusion
• Building sustainable competitive advantage requires a
knowledge of the full linked set of value activities of which
the firm and its competitors are a part
• Once the value chain is fully articulated, critical strategic
decisions about make/buy and forward/backward integration
become clearer
• Investment decisions can be viewed from the perspective of
their impact on the overall chain and the firm’s position
within it
• For strategic decision making, cost analysis today cannot
afford to ignore the value chain dimension

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