Industry value chains have become noticeably unsteady. They are subject to constant change driven by mergers, overlapping industries, blurred lines from new technologies, and disintermediation by new entrants. Within this context of market change, earnings regularly get affected.
A common problem occurs when the industry value chain squeezes a company on both sides, i.e., from customers and suppliers. Other prevalent forms of downward pressure of the value chain on earnings result from long value chains or profit shifts along the chain. Here is what we see.
1. Value chain squeeze.
2. Long industry value chain.
3. Profit shift along the chain.
In addition to the industry value chain, the company’s value chain can also hurt the firm’s economics. Here are two common issues that we see.
4. Long company value chain.
5. Multiple company value chains.
FIXING THE PROBLEMS
These problems unfold gradually and take a long time to manifest because management teams are usually concerned with other immediate issues. However, the longer these situations persist, the more intense the pressure on earnings. Over time, the firm’s economic position can become severely compromised to the point of not covering the cost of capital and impairing the company’s competitive position. While every company is different, fundamental questions to help guide management in these situations include the following:
- How is the industry value chain impacting the firm’s economics?
- What are the stages in the industry value chain and where are profits being made?
- Are we being squeezed for profits? Are there underlying power shifts taking place?
- Where and what are the strategic controls points in the industry?
- Is the company’s value chain impacting its cost economics favorably or unfavorably?
The prescription for solving downward pressure of the value chain on the company’s earnings is to respond strategically. Companies can use various value-chain strategies to improve returns and strategic control and exploit hidden opportunities. These strategies modify the firm’s value chain in the context of customers, suppliers, and the industry as a whole.