Corinne Vadcar / Senior Trade Analyst, Institut Friedland / 2016-07-18
The slowdown in international trade and the digital revolution converge to shake up global value chains, a paradigm for international trade since approximately 25 years. A value chain, it should be recalled, encompasses all of the activities that form a product or service, from its conception to its use by the end consumer. The globalization of value chains that began in the early 1990s opened a cycle that now seems to bend. On these different links, the way value is created changes greatly. Western companies draw lessons by changing their business model. But emerging countries have also entered the game. Ultimately, maybe only a few winners with a global corporate status will be left.
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Global value chains at the crossroads of three major mutations
With the global fragmentation of production networks, Western companies have increasingly captured value on the downstream and upstream segments of production and assembly; this development was formalized in 1992 by the founder of Acer, Stan Shih, with his famous smiling curve model.
Today, this development in the creation of value at both ends of a firm’s chain of activities (i.e. R&D and customer service) is reinforced by two factors: firstly, the interconnectivity of consumer goods and services and that of equipment and industrial processes; secondly, the unprecedented role of consumers in the chain. On these two segments, the company develops increasingly immaterial activities.
The growth of services in global economy is one of the transformation vectors of global chains. Tomorrow, value chains of goods could be dwarfed by value chains of services. According to a recent study of the WTO, this perspective proves even more difficult to capture, because it implies a better understanding of the characteristics per company and per mode of supply.
Finally, with the intrusion of digital technology in production, traditional sectors are no longer valid. The concept of product value chain is more appropriate than that of sectoralvalue chain. Applications and services differ greatly according to the product; the variety of actors – from traditional economy and new economy – will be particularly great according to the product.
In order to foreshadow new global value chains, companies are therefore evolving their business model. Value creation can be optimized in three segments.
Value creation in the product offer
Irrespective of the high-end or luxury sectors (German carmakers, French or Italian haute couture, etc.), a number of companies have realized in recent years, the benefit they can withdraw from a brand positioning. Georges Lewi, trademarks specialist, determined that an unbranded product sold for €100, could be sold for €115 to €130 with a normal brand and €1,000 with a luxury brand.
Whether or not they are in a logic of sourcing and procurement, companies of the medium or upper-medium range have therefore invested in the brand to capture value. According to the ECIPE, brand-intensive sectors represent 34% of GDP and 20% of employment in Europe. The brand has a strong power of attraction among middle classes in the world. It is also an intangible asset and foreign economies seek to understand its drivers and process of formation.
Because it has little control over strong brands, China fall into this model. At the Milan Universal Exposition (2015), the Chinese tried to present little known businesses (Tanlon, Prolivon) as design manufacturers or original brands, not just manufacturers of original equipment. The exercise doesn’t seem convincing (not yet, at least).
For now, buying Western or Japanese brands seems more effective. In the clothing/fashion industry, the Shandong Ruyi industrial group has acquired the GSPC group, keeping the brands that form part of it (Sandro, Maje and Claudie Pierlot). In electronics, Taiwanese companies acquired strong Japanese brands: the Chinese group Haier has reached an agreement with Panasonic in 2011 that gave them the right to use the Sanyo brand on Southeast Asia markets. The Taiwanese brand Foxconn was forced to divest Sharp’s TV branch. Finally, trademark license agreements are signed between Taiwanese brands and strong manufacturers such as Toshiba (lighting branch). In the model built by Toshiba, the Taiwanese buyer gains market shares in Europe by applying the Toshiba trademark on LED bulbs they produce and package themselves; meanwhile, the Japanese group validates each product, ensures the preservation of the brand and receives royalties.
The brand effect is also closely linked to the origin; this latter factor can be a powerful source of value creation. Origin, just like the brand itself, can often be linked to a historical legacy that allows a great storytelling. In France, the segment of tableware, and more recently, that of furnishing, have understood the value of this intangible capital value without entering into a logic of labels. The origin could even convey a stronger value than the slightly more industrial concept of “made in”.
The premium positioning of a product is bound to the brand. This development is clearly seen in the automotive sector, with actors such as Renault attempting to escape from the medium range pitfall in order to sell vehicles with a higher added value. In the automotive equipment industry, Plastic Omnium has acquired the bumper branch of Faurecia to be closer to high-end automaker clients. Another particularly emblematic sector of this exit by the top: appliances. The positioning of US companies such as Ariston or of British firms such as Dyson encouraged Samsung to impose itself in the upscale segment (refrigerators).
Subsequently, at the present day, products should have a content in R&D (product innovation) and knowledge (knowledged-based goods), both powerful drivers in a global economy based on innovation. This is evidenced by the market of smartphones or connected devices (IoT), always struggling to win acceptance as soon as they don’t have any breakthrough innovation or new features to offer.
However, we deal with a world where products are increasingly less an object of value. R&D is necessary but not enough. Companies that target innovation and design with their business model must, at the same time, provide connectivity to equipment and consumer goods. Beautiful or good products are no longer an end in itself. Good products are those that deliver the best digital services and applications for data management and analysis. This is the meaning of alliances between global corporations and digital actors. A Renault vehicle such as the Koleos is equipped with Apple’s Car Play system, a smarter and safer way to use an iPhone in the car.
Thus, the value of a product (or service) is now based on its connectivity and relationship with the customer.
The creation of value in the customer relationship
The customer relationship becomes a strong driver for the creation of value: firstly, because global value chains tend to be increasingly driven by the final consumer; secondly, because digital technologies optimize customer relationships. The massive recovery of big data coupled to data analytics allows to observe the uses not only in order to adapt the offer of goods or services, but also to add value before they reach the final customer.
To move closer to the client, Xerox uses a set of connected tools to identify the renewal rate on printers and fax machines. In 2014, Lenovo bought IBM’s entry-level server activity to massively exploit corporate data. Lastly, with its Dragon Boat project, Amazon invested in transportation and logistics to disintermediate the value chain but also to improve the responsiveness of end clients.
At this stage, one feels that a range of upstream or downstream services of a product’s omnichannel delivery (e-commerce and traditional commerce) will help renew the modes of value creation across the segments in the chain: outbound logistics, distribution, marketing, customer service, etc. but also conception, design, quality or the origin of inputs in the final product, in order to respond more precisely to customer requirements. In e-commerce, Alibaba’s alliance with Amazon on the Chinese market illustrates the Chinese group’s intention to improve the management of its customer service based on the experience of the US group. Conditions of access of a product become as important as its physical delivery.
Similarly, the need to get closer to customers enhances the practice of reverse innovation. For a Western company, the latter consists in designing and selling a product by taking into account its uses in an emerging/developing country, before hitting Western markets. In appliances, Seb sold several flagship products (around rice or tea) by observing modes of preparation in Asia and developing partnerships with local players. This approach is relevant in emerging markets at a time when the growing importance of national champions and local brands increases competition.
Finally, to capture a larger share of value from the chains, actors upstream of distribution strive to take an active part within the distribution itself. Manufacturers such as Gautier, Guy Degrenne, Repetto or Armor Lux open their own stores rather than using dedicated networks or becoming both producers and distributors.
The strategic importance of customer relationships in value creation leads, ultimately, to developing and optimizing service delivery.
Value creation in services
Western economies are largely service-based. Two factors are chiefly responsible for this: the global fragmentation of production networks has led, in different countries, to de-industrialization on the one hand and to significant, societal, changes based on services, on the other. The importance of using one’s own product and the margin generated on high value-added services participate to this movement. Samsung has recently launched a service (Up2Yo) for renting smartphones and changing terminals as soon as newer models are released. However, this trend focused on use isn’t observed for all products and in all regions of the world.
In this evolution towards a more global economy focused on services, software will play a fundamental role. So many actors already manufacture their own hardware. The next move consists in aiming at higher-value software and developing a business model for services for both businesses and individuals.
On the declining market of smartphones, Samsung has begun the structural shift towards software. Chinese hardware players such as Huawei and Xiaomi are not outdone. The latter has signed a partnership with Microsoft that grants the right to install technologies for voice communication, video, multimedia and online storage, pre-installed Microsoft software (Office suite: Word, Excel…) on its smartphones.
However, business strategies are relatively diversified. Some integrate a business model completely rooted in services; others extend their product offer through services and others incorporate an increasing share of services within goods (i.e. servicification). Many large groups have already created a services division.
“We are all software companies now”, said Mark Muro. An increasing number of companies will, in fact, become software players.
What can we learn from these new business models?
The question of value creation should be largely revised.
First, much of the value has been, up to now, captured by businesses on global chains by creating barriers to entry. This model is resistant in some areas because challengers are struggling to overcome these barriers. Proof of this is the difficulty of South Korean fashion brands to be exported outside their country or Asia… but will erecting barriers to entry be enough in the future to keep up with the developments observed?
– Chinese groups are buying an increasing number of Western brands;
– They acquire strong positions while, at the same time, erecting barriers;
– US retailers/distributors (eg fashion brands) face many difficulties in the model for driving and creating value because of their lack of proximity with clients.
Another comment: agility remains the golden rule to strengthen a position on a global value chain. The mechanism of chains allowed to integrate companies of different sizes and models. This observation remains valid. Remaining agile on a chain means being able to change business models as often as necessary. Similarly, choosing one business model doesn’t rule out using other models to capture a greater share of value on a global chain.
Michelin targets highly differentiated foreign markets and aims several goals: presence in growth segments (tourism), mixed offer of tires (premium and entry level) and services around mobility. Similarly, the strategic plan (Push to Pass) of the PSA Group from 2016 to 2021 is based on five axes for the development of several business models: 1/ from the product to the customer, 2/ from ownership to experience, 3/ from car to mobility, 4/ from local to global, and 5/ from one activity to a portfolio of activities.
Moreover, digital technologies are clearly not based on a unique business model. They allow for development or optimization. In other words, a business model cannot be created based on technology. Therefore, companies must avoid polarization on technology and keep “business use in mind” instead.
Lastly, even if a company communicates increasingly on its business model, the means to implement this model are kept confidential. Therefore, for many years, Michelin kept the secret around the manufacturing process of its tires in 3D (Cross Climate). Similarly, innovation in Japanese companies is particularly protected. This is the price businesses must pay to generate margins during the two first years of life of a product, when it isn’t duplicated and trivialized yet.
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In conclusion, conventional modes of value creation losing their efficiency. At the same time, it is increasingly difficult to lead winning growth strategies when facing new entrants in digital technologies and new challengers from emerging countries. This shows the importance of an economic environment that captures the best of how value will be created in the future. At this stage, one feels that the globalization of services could be the main challenge during the coming years. Companies will probably aim becoming agents of services. To paraphrase Mark Muro: “They will all be services companies!”
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