Supply Chain Management, Value Chain, Vertical Coordination and Vertical Integration

Dr. Jabir Ali Associate Professor Centre for Food &Agribusiness Management Indian Institute of Management, Lucknow 226 013

Stages in Evolution of Food Supply Chain

1 T I M E P CON

S&M

CON

S&M 3 P LR CON

P=Producer CON=Consumer S&M= Small and Medium Intermediaries LR= Large Intermediaries

Complex Agricultural Supply Chain System

Input supply

Retail distribution: Supermarkets Grocery stores

Producers

Consumers Mandi/ Wholesalers

Processors

Institutional Distribution: Restaurants Fast food operations Institutions

Supply Chain Management

Supply Chain the core business processes in an organization that create and deliver a product or service, from concept through development and manufacturing or conversion, and into a market for consumption Supply Chain Management the methods, systems and leadership that continuously improve integration across all core business processes

Evolution of logistics and supply chain concepts, 19602000

Term first coined by Oliver and Webber in 1982

What is Supply Chain Management?

Developing a chain that links producers with consumers

Each component of the supply chain is connected to other parts of the supply chain by
o o o the flow of goods and services in one direction, the flow of orders and money in the other direction, and the flow of information in both directions.

Focuses both on backward and forward activities

Upstream the processes which occur before manufacturing or production into a deliverable product or service, typically processes dedicated to getting raw materials from suppliers Downstream the processes which occur after manufacturing or production, typically those processes dedicated to getting goods and services to customers and consumers

Flows in a Supply Chain

Information Product
Suppliers Customer

Funds

Defining Value Chain?

The value chain: describes the activities that take place in a business and relates them to an analysis of the competitive strength of the business. Value Chain Analysis is one way of identifying which activities are best undertaken by a business and which are best provided by others ("out sourced"). This involves:
o o identifying the outline of the chain and the position of the various agents within it, developing the economic accounts cost, profit margins, wastages etc corresponding to the activities of the agents involved in the chain.
Factors of PRODUCTIVE AGENT Product

production

Vertical Coordination
Refers to all possible economic arrangements involved in transferring resources between economic stages o Farm production o Processing o Wholesaling o Retailing Ways of achieving vertical coordination: o Open Market: A firm purchases commodity from a producer at a market price determined at the time of purchase. o Contracting: A firm commits to purchase commodity from a producer at a price formula established in advance of the purchase. o Vertical Integration: A single firm controls the flow of commodity across two or more stages of production.

Why VC?
o o o Transaction costs vs. physical cost Efficiency in chain Relationship

Types of Integration
Quasi-vertical integration: o A relationship between buyers and sellers that involves a long-term contractual obligation where both parties invest resources in the relationship o Participants share the costs, risks, profits and losses of the venture o Examples: JV, Franchises and Licenses Tapered vertical integration: o The occurs when a firm is partially integrated backward or forward. o Examples:
a food processing firm integrated backwards could obtain a portion of its raw material supplies from its integrated farms with the remainder procured from auction markets or direct from producers. Similarly, a firm could sell a portion of output forward through its own distribution network, with the remainder sold in the open market

Types of Integration
Full vertical integration:
o This occurs when one firm carries out two or more consecutive stages of the production-distribution chain. o A firm can be integrated forward (downstream) into distribution or retail functions or backwards (upstream) into supply functions

Horizontally integrated networks:

o Refers to the relationship between businesses serving similar markets, producing similar products etc.

Factors affecting VC
Transaction costs

Uncertainty

Asset specificity

Transaction costs? Origin

Assumptions of neoclassical economic theory
o o o o Perfect knowledge Cost-less flow of information No externalities That means transactions take place in a frictionless environment, and cost of exchange is zero. Imperfect knowledge A number of factors (non-price) influence transactions Information is asymmetric, and its acquisition is not without cost. Thus there are costs associated with exchange

The real world situation is different

o o o o

Components of transaction cots

Ex ante: Information costs
o o Information search: prices, quality, identification of potential buyers Screening of information: Compilation and processing of information of the potential partners, prices and quality Bargaining costs Contract design: legal fees, notary charges Monitoring of contract Enforcement of contract Protection of rights against third party encroachment Transfer of goods and services: transport, storage, processing, retailing, wholesaling, losses, etc.

Negotiation costs
o o o o o o

Ex post or Monitoring and Enforcement costs

Factor Affecting the Transactions in Supply Chain

Transaction Costs

Drivers Technological Regulatory Socio-Economic

Product Characteristics

Transaction Characteristics Most

Coordination

Perishability Product differentiation Seasonality Quality Variability Safety Branding and Packaging Consumer Choice

Vertical Integration

Uncertainty Reliable Supply Frequency of transaction Relationship specific investment Complexity of transaction

Resource Providing Contract

Market-specific Contract

Transaction Cost: Ex ante: the expenditure of time and resources for identifying suitable trading partner, specifying/Identifying product quality, gathering information etc Ex post: monitoring and enforcement costs

Open Market

Least

Factors influencing : Asset specificity

Asset specificity: lack of transferability of the asset from its intended use to alternative uses. This could be due to: o Technical characteristics of the asset o Market imperfections

As an asset becomes more specialized, its resale or salvage value declines.

Types: site, physical assets, human capital, temporal Asset specificity influences bargaining power and monitoring and enforcement costs o When market is not competitive o When market is competitive

Higher the asset specificity, the greater is a tendency towards vertically coordinated supply chain

Relationship between asset specificity, transaction costs and method of vertical coordination
k=level of asset specificity M(k)=transaction costs with spot market C(k)= transaction costs with contracting V(k)= transaction costs with vertical integration

Factors influencing: uncertainty

Uncertainty is result of information asymmetry It increases costs of information, negotiation and monitoring and enforcement , and the firm invest more in search of honest and trustworthy partners.

The firm prefers vertically coordinated supply chain for transactions involving uncertainty, and use various instruments such as provision of
inputs, services, credit, incentives to make it work.

Sources of uncertainty:
o o o Technological changes Unpredictable change in consumer preferences Random acts of nature

Shifting focus in supply chains

Shift 1: From Cross-Functional Integration to Cross-Enterprise o Old question: how do we get the various functional areas of our company to work together to supply product to immediate customers? o New question: how to record and do activities across companies, as well as across internal functions, to supply product to the market? Shift 2: From Physical Efficiency to Market Mediation/ Negotiation o Old question: how do we minimize the costs our company incurs in production and distribution of our products? o New question: how do we minimize the cost of matching supply and demand while continuing to reduce the costs of production and distribution? Shift 3: From Supply Focus to Demand Focus. o Old question: how can we improve the way we supply product in order to match supply and demand better, given the demand pattern? o New question: how can we get earlier demand information or affect the demand pattern to match supply and demand?

Shifting focus in supply chains

Shift 4: From single company, product design to collaborative, concurrent product, process and supply chain design o Old question: how should our company design products to minimize product cost (our cost of materials, production, and distribution)? o New question: how should collaborators designed the product, process, and supply chain to minimize cost? Shift 5: From cost reduction to breakthrough business models. o Old question: how can we reduce our company's production and distribution costs? o New question: what new supply chain and marketing approach would lead to a breakthrough in customer value? Shift 6: From mass-market supply to tailored offerings. o Old question: how should we organize our company's operations to serve the mass-market efficiently while offering customized product? o New question: how should we organize a supply chain to serve each customer or segment uniquely and provide a tailored customer experience?