Forecast digital disruption using value chain models

Use value chains to model industries and predict possible digital disruptions before they actually happen.

In the face of ongoing digitization, many established businesses find themselves challenged by old or new participants. New apps and platforms can make established intermediaries obsolete, digital delivery can replace traditional logistics- and retail networks. This trend is of similar scope as the wave of globalization the world experienced in the previous century. Many raw material- and manufacturing functions were moved abroad. This mostly concerned the lower end of the supply chain. With digitization it’s different. Changes and disruptions can occur at any location in the supply chain.

This white paper presents a way to model value creation around a product or industry and forecast potential disruptions enabled by digital technology.

It is directed at managers of established businesses, as well as startup founders. The former group can use the proposed techniques to identify and participated possible supply chain disruptions in their industry. The latter can identify new ways to create value and position their startup.

Modeling Value Chains

The idea of drawing value chains as flowchart-style graphs is not new. Michael Porter1 used the technique for finding competitive advantages within business units. He assumed the surrounding value system to be fixed and looked at primary and secondary business functions for possible improvements and advantages.

Supply chain management literature2 also uses a model of successive business functions, like manufacturing, wholesale and retail to improve the workings of the overall system. As opposed to value chains, supply chains are mostly concerned with logistics flows, rather than “value” in the broader sense. A super market renting retail space or buying TV ads is clearly adding value for the end user with these two activities. Yet, supply chain management would mainly look at inventory and the flow of the actual product. Since digital processes don’t just disrupt the flow and ownership of physical products, it’s better to include any process adding value to the product mix as a whole.

This is what David Rogers suggested with his value train3, a chain of consecutive actors adding value to the final product. At each step, one can look at possible competitors, both traditional and digital.

In this white paper, we will use a mix of all above mentioned tools and pick the most appropriate aspect from each. This will allow for a focus on value added (as opposed to the flow of physical goods) and also for more complexity than a single-thread value train.

Figure 1: Local food production value chain

Figure 1 shows a simple (local) value chain for food production. At the beginning of the chain is a farmer producing milk, grain or other agricultural raw materials. These are delivered to a food processor, who in turns sells them to a wholesaler or delivers them to the distribution center (DC) of a chain of supermarkets. Note that the owner of both – the distribution center and supermarket – could be the same. Since they perform different functions in the value chain, they are still modelled separately.

When drawing up a value chain, it can be difficult to decide on the level of detail. As a rule of thumb, it’s suggested to include any factor representing a significant expense or significant source of value.

Examples for digital disruption

Value chain disruption can originate from any alteration of the existing chain that either adds, removes or skips existing participants. The value to the end user can stay the same or increase. In some cases, the new value chain could only server a subset of the current end users. These ideas are best illustrated with examples of well-known previous disruptions.

Figure 2 shows a very simple value chain for a generic insurance product. E.g. car insurance. An insurance company would sell coverage to end users via agents and advertise for the whole group through traditional TV or newspaper channels.

Figure 2: Simplified insurance value chain

In figure 3, two small changes are made to the value chain: insurance agents are replaced with online price comparison sites. In the beginning this change will only affect part of the value chain. End users buying more complicated products or older users may still opt for insurance agents instead of online platforms. But a significant part of simple insurance products, like car insurance will be handled by the new value chain.

Figure 3: Insurance value chain with online price comparison sites

 

Another example for a disruption is the publishing industry. Figure 4 displays a very traditional value chain for writing, publishing and distribution books: Books are written by authors. Editors help either the author or publishing company to edit the text. Illustrators provider the publishers with images. The publisher then prints the book (assuming printing isn’t outsourced) and ships it to retailers via wholesalers or retailer’s own distribution centers. Retails rent space from commercial real estate providers and buy advertising space on traditional media channels.

Figure 4: Traditional book publishing value chain

This model was severely interrupted by the digital delivery of books to tablet devices, like Kindles. As a result, part of the value chain switched to a more direct model with a lot fewer intermediaries. Figure 5 shows a revised chain for digital distribution. Authors as original content creators now write books and buy illustration- and editing services directly. They then publish their books on online publishing platforms, which handle formats, payment and curation. Some authors could also sell directly to consumers, without using an online publisher, like Amazon.

Figure 5: Disrupted book publishing value chain

The book industry provides a more extreme example of disruption, than the insurance industry. In the former, the product’s nature fundamentally changed from printed paper to digital files, while providing a very similar reading experience to the end user. This transformation in the product gave rise to a very different value chain.

In the insurance example, only part of the distribution chain changed. The intangible insurance service stayed the same. One could think of a more drastic disruption in the future, like crowd-based insurance provided by a fintech company.

Categories of value chain disruptions

Analyzing past disruptions is mostly an academic exercise. The real business value comes from predicting and possibly exploiting disruptions enabled by technology. This part will show distinct categories of disruptions, to help you recognize them later.

Figure 6 shows a very classic value chain for consumer electronics, like computers or other gadgets. It will serve as example to find patterns and predict future disruptions.

Figure 6: consumer electronics supply chain

This simplified model starts with chip- and display manufacturers (possibly based in Korea or Japan) and continues with OEM factories (maybe located in China). The next party are hardware brands doing design, R&D and possibly marketing. Then the products are imported by wholesalers and sold in retail stores.

Some options for the disruption of this value chain are:

Intermediation

A new party manages to perform a new value chain function that increases total value. An example could be price comparison sites allowing the end user to access a wider product range at a better price. In this case retailers would likely lose some of their profits, end uses would gain and comparison sites would gain as well. The rest would stay the same. This example shows that parties who fail to create value near their functions can find some of their gains transferred to new participants.

Figure 7: Online price comparison site as new intermediary

Intermediation happens, where value could be added to the value chain, but isn’t by existing parties. Often close to the end user.

Disintermediation

This kind of disruption skips over some value chain parties, while providing a similar end product to the end user. Sometimes value chain functions are skipped altogether, but most often they are simply performed by another party or consolidated in one company. This often happens to functions that don’t directly contribute to the core value of the product.

Figure 8: Online shopping portal fulfilling most distribution functions

In figure 8 OEM manufacturers directly sell to end users via online shopping portals, like Ebay, Amazon or AliExpress. Value chain functions previously performed by the retailer, importer or reseller are now performed by other parties.

Value chain disruptions often happen to intermediaries, after the end product was created.

As can be seen in this example the vulnerable places in the value chain are between the creation of the final (physical) product and the end user. When recalling the insurance example, a reinsurer won’t offer car insurance, but after the creation of the end product, all intermediaries are in danger. The book value chain gave a similar lesson. There it could be argued, whether the author or the publisher creates the final product.

Consolidation

Similar to disintermediation, but doesn’t skip any existing business functions. Figure 9 shows an example of a single company consolidating a number of functions into one entity. A real-life example could be Apple Computers. After opening its own stores, Apple replaced traditional importers and retailers. By partly taking over chip design, they replaced traditional GPU and CPU manufacturers. This tight integration helped Apple to increase the value to the end user by selling highly integrated devices that worked better than splitting operating system- and hardware design across separate entities.

Figure 9: Integrated hardware company consolidating most value chain functions in a single entity.

Consolidation keeps business functions and the product the same. Thus it’s most difficult to add extra value by combining them. Many value chains work more efficient as separate entities.

Steps to predict value chain disruptions

The previous part explained how to model value chains and gave examples of disruption categories. The underlying reason are either changes in the product or possible changes in the business functions delivering the product to add value or replace functions. Table 1 summarizes those options and their possible outcomes.

Practical steps to identify possible digital disruptions in your industry would be:

  1. Model the relevant part of the value chain in sufficient detail.
  2. Write down the capabilities of each party. An OEM manufacturer may be able to sell his widgets online, but could lack critical design capabilities.
  3. Evaluate new value chains, resulting from altered business functions (e.g. selling via online shop instead of retailer).
  4. Evaluate new value chains, resulting from a changed product, providing similar end user value (e.g. reading books on Kindle).
  5. Draft new, changed value chain and determine if your organization can take advantage of these changes.
Table 1: Possible outcomes when products or business functions change.
Business functions unchanged Business functions changed
Product unchanged Low potential for disruption. Added value needs to come from previously unavailable synergies. Consolidation. Value creation steps are skipped or altered while still providing the same product. Medium to high potential for disruption. Intermediation or disintermediation.
Product changed - A changed product will almost always alter business function and provide high potential for disruption. Disintermediation.

Conclusion

Your business is part of a value chain with an end user and multiple subsequent partners. Applying technological – no matter how sophisticated – can shift the entire chain and add or remove participants from it.

To avoid surprises, model the value chains you are part of and look at different scenarios. If you find any opportunities for disruption, be the first to move or others will.

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