value chains

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1 OM3 Chapter 2 Value Chains © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. VALUE CHAINS CHAPTER 2 DAVID A. COLLIER AND JAMES R. EVANS

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VALUE CHAINS. CHAPTER 2. DAVID A. COLLIER AND JAMES R. EVANS. LO1 Explain the concept of value and how it can be increased. LO2 Describe a value chain and the two major perspectives that characterize it . LO3 Explain outsourcing and vertical integration in value chains . - PowerPoint PPT Presentation

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1OM3 Chapter 2  Value Chains © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

VALUE CHAINS

CHAPTER 2

DAVID A. COLLIER AND JAMES R. EVANS

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2OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

LO1 Explain the concept of value and how it can be increased.

LO2 Describe a value chain and the two majorperspectives that characterize it.

LO3 Explain outsourcing and vertical integration in value chains.

LO4 Explain offshoring and issues that managers must consider in offshoring decisions.

LO5 Identify important issues associated with value chains in a global business environment.

LO6 Describe how sustainability plays an important role in value chains.

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3OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

A pple has mastered the art of blending physical

goods with services to create value for its customers. Think iPod + iTunes, iPhone + apps, iPad +videos; well, you get the picture. Apple was recognized as having "an intoxicating mix of brilliant industrial design, transcendent software interfaces and consumable goods that are purely digital… The mechanical and financial benefits of this approach include extremely high inventory turns, minimal material or capacity limitations to growth, and excellent margins.” When Apple introduced the 3G iPhone in July of 2008, there were plenty of phones available in Apple stores. In just three days, Apple sold 1 million iPhones.

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4OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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The processes by which the physical goods are produced and delivered, called the supply chain—that is, purchasing raw materials, manufacturing the phones, and distributing them to retail outlets—worked marvelously. However, one part of the service side of Apple’s business did not work as smoothly. During those first few launch days, iTunes was not able to deal with the huge number of demands for phone activations that came from 21 different countries, overwhelming call center and server capacity, resulting in many frustrated customers.

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5OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Cite some other examples in which digital content has been combined with a physical good. How do you see the digital revolution changing the nature of physical goods in the future?

What do you think?

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6OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Value and Supply Chains

• A value chain is a network of facilities and processes that describes the flow of goods, services, information, and financial transactions from suppliers through the facilities and processes that create goods and services and deliver them to customers.

• A supply chain is the portion of the value chain that focuses primarily on the physical movement of goods and materials, and supporting flows of information and financial transactions through the supply, production, and distribution processes.

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7OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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The Concept of Value

• The underlying purpose of every organization is to provide value to its customer and stakeholders.

• Value is the perception of the benefits associated with a good, service, or bundle of goods and services (i.e., the customer benefit package) in relation to what buyers are willing to pay for them.

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8OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Porter Model (1985)

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9OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Creating “Value” for Shareholders [Lee, 2012]:

• Creating Value = Shareholders’ wealth maximization

• Value = shareholders’ wealth• Shareholders’ wealth = stock price• Stock price = firm value / # of outstanding

common stocks• Firm value = profit (EBIT) / cost of capital• Profit = total revenue – total cost• Conclusion: To increase value for shareholders,

we have to create “value” in all activities inside of the firm (Primary & Support Activities), and in the Industry value chain, meaning we have to increase revenue & decrease cost every where possible.

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10OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Perceived benefits Value =

Price (cost) to the customer

If the value ratio is high, the good or service is perceived favorably by customers, and the organization providing it is more likely to be successful. To increase value, an organization must:

(a) increase perceived benefits while holding price or cost constant, (b) increase perceived benefits while reducing price or cost, or (c) decrease price or cost while holding perceived benefits constant.

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11OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Value Chain Paradigms and Perspectives

• Input-Output Model: A value chain begins with suppliers who provide inputs that are transformed into value-added goods and services through processes that are supported by resources such as equipment and facilities, labor, money, and information. These goods and services are delivered or provided to customers and targeted market segments.

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12OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Exhibit 2.1 An Input-Output Perspective of a Value Chain

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13OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

Exhibit 2.2 Examples of Goods-Producing and Service-Providing Value Chains

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14OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Buhrke Industries, Inc. Value Chain

• Buhrke Industries Inc., located in Arlington Heights, Illinois, provides stamped metal parts to many industries, including automotive, appliance, computer, electronics, hardware, house wares, power tools, medical, and telecommunications.

• Buhrke’s objective is to be a customer’s best total-value producer with on-time delivery, fewer rejects, and high-quality stampings. However, the company goes beyond manufacturing goods; it prides itself in providing the best service available as part of its customer value chain.

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15OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Exhibit 2.3 The Value Chain at Buhrke Industries

Source: Buhrke Industries company web site

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16OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Buhrke Industries, Inc. Value Chain

• Service is more than delivering a product on-time. It’s also partnering with customers by providing personalized service for fast, accurate response; customized engineering designs to meet customer needs; preventive maintenance systems to ensure high machine uptime; experienced, highly trained, long-term employees; and troubleshooting by a knowledgeable sales staff.

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Value Chain Paradigms and Perspectives

• Pre- and Postproduction Services Perspective: Pre- and postproduction services complete the ownership cycle for the good or service. Pre-production services are focused on “gaining a customer.” Postproduction services focus on “keeping the customer.” This view of the value chain emphasizes the notion that service is a critical component of traditional manufacturing processes.

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18OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Exhibit 2.4 Pre- and Post-Service View of the Value Chain

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Nestle—A Service View of a Business

• Nestle defines its business initially from a physical goods viewpoint; later from a service perspective.

• The results were greatly increased Nestle coffee sales, new revenue opportunities, and much stronger profits.

• Nestle’s service vision of their business required a completely new service and logistical value chain capability.

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21OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Value and Supply Chains

A supply chain is the portion of the value chain that focuses primarily on the physical movement of goods and materials, and supporting flows of information and financial transactions through the supply, production, and distribution processes.

Many organizations use the terms “value chain” and “supply chain” interchangeably; however, we differentiate these two terms in this book.

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22OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Value and Supply Chains

A value chain is broader in scope than a supply chain, and encompasses all pre- and postproduction services (see Exhibit 2.3) to create and deliver the entire customer benefit package.

A value chain views an organization from the customer’s perspective—the integration of goods and services to create value—while a supply chain is more internally-focused on the creation of physical goods.

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Exhibit 2.4 Pre- and Post-Service View of the Value Chain

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24OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Exhibit 2.5 A Value Chain Model of Dell, Inc.

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25OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Value Chain Decisions

The operational structure of a value chain is the configuration of resources such as suppliers, factories, warehouses, distributors, technical support centers, engineering design and sales offices, and communication links.

Value chains may be centralized or decentralized.

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26OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Outsourcing and Vertical Integration

• Vertical integration refers to the process of acquiring and consolidating elements of a value chain to achieve more control.

• Backward integration refers to acquiring capabilities toward suppliers, while forward integration refers to acquiring capabilities toward distribution or even customers.

• Outsourcing is the process of having suppliers provide goods and services that were previously provided internally.

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27OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Three Waves of Outsourcing

1. Outsourcing goods-producing jobs, such as computer components and electronics from the U.S. in many industries several decades ago.

2. Outsourcing simple service work, such as standard credit card processing, billing and other forms of transaction processing, and software development.

3. Outsourcing skilled knowledge work, such as engineering design, architectural plans, call centers, and computer chip design.

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28OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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The Economics of Outsourcing

VC1 = Variable cost/unit if produced

VC2 = Variable cost/unit if outsourced

FC = Fixed costs associated with producing the part

Q = Quantity produced (volume)Total cost of production = (VC1)Q + FC

Total cost of outsourcing = (VC2) Q

Find the breakeven point: (VC2)Q = (VC1)Q + FC VC2 − VC1

FC[2.1]Q* =

Outsourcing Equilibrium Model [Collier & Evans, 2012]

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29OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Interpretation of the Results:

• If a firm’s anticipated volume < Q* (break-even quantity), the firm should go for the outsourcing decision.

• If the anticipated volume > Q*, the firm can afford in-house operation.

Outsourcing Equilibrium Model [Collier & Evans, 2012]

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30OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Solved Problem—In-House versus Outsource

Suppose that a manufacturer needs to produce a custom aluminum housing for a special customer order. Because it currently does not have the equipment necessary to make the housing, it would have to acquire machines and tooling at a fixed cost (net of salvage value after the project is completed) of $250,000. The variable cost of production is estimated to be $20 per unit. The company can outsource the housing to a metal fabricator at a cost of $35 per unit. The customer order is for 12,000 units. What should they do?

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31OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Solution

VC1 = Variable cost/unit if produced = $20

VC2 = Variable cost/unit if outsourced = $35

FC = fixed costs associated with producing the part = $250,000

Q = quantity produced

Using Equation 2.1 we obtain: Q = 250,000/($35 - $20) = 16,667

In this case, because the customer order is for only 12,000 units, which is less than the break-even point, the least cost decision is to outsource the component.

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32OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Outsourcing in 1980s - Present [Lee, 2012]

• Theoretically, VC2 was supposed to be higher than VC1. In 1980s, four small countries in Asia (a.k.a. four tigers) presented VC2 that was even lower than VC1.

• Outsourcing Equilibrium Model tells us that we will never get Q* when VC2 < VC1, for the two lines will not cross each other.

• To maintain economic sustainability, U.S. firms had to choose “outsourcing” to the four tigers. Otherwise, the U.S. firms would lose competitive advantage in the global markets.

• In 1990s, the four tigers became rich & democracy with labor union, and could no longer offer low VC2. .

• China filled the vacuum. • The labor cost in China is increasing, and now China is

beginning to outsource to other countries – Vietnam, Bangladesh, etc.

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33OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Managerial Implications [Lee, 2012]

• When a firm makes a decision to outsource its operations, the firm faces violent opposition from labor union, community, politicians, customers, etc.

• It is a manager like you who should take responsibility to explain to them, and gain their support on the corporate decision.

• One way is to present scientific evidence using the Outsourcing Equilibrium Model [Collier & Evans, 2012].

• Show them the data & graph which illustrate that VC2 < VC1, which will lead to a failure to reach the break even quantity (Q*) indefinitely because VC2 and VC1 will never cross each other, and thus no equilibrium (= Q*) can be made.

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34OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

Value chain integration is the process of managing information, physical goods, and services to ensure their availability at the right place, at the right time, at the right cost, at the right quantity, and with the highest attention to quality.

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CHAPTER 2 VALUE CHAINS

Value chain integration in manufacturing•Consolidating information systems among suppliers, factories, distributors, and customers.•Managing the supply chain and scheduling factories.•Studying new ways to use technology.

Value chain integration in services•Third-party integrators for the leisure and travel industry (e.g., Orbitz, and Travelocity). •Information networks provided by third-party information technology integrators. •Third-party integrators that manage patient billing and hospital inventories.

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36OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

Offshoring is the building, acquiring, or moving of process capabilities from a domestic location to another country location while maintaining ownership and control.

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37OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

Exhibit 2.6 Things to Consider When Making Offshore Decisions

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38OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

Value Chains in a Global Business Environment

A multinational enterprise is an organization that sources, markets, and produces its goods and services in several countries to minimize costs, and to maximize profit, customer satisfaction, and social welfare.

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39OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Challenges Facing Multinational Enterprises

1.How to design a value chain to meet the slower growth of industrialized countries and more rapid growth of emerging economies.2.Where to locate manufacturing and distribution facilities around the globe to capitalize on value chain efficiencies and improve customer value.3.What performance metrics to use in making critical value chain decisions.4.How to decide if partnerships should be developed with competitors to share engineering, manufacturing, or distribution technology and knowledge.

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40OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

Rocky Brands, Inc.

• Rocky Brands (www.rockyboots.com) headquartered in Nelsonville, Ohio, manufactures rugged leather shoes for hiking and camping.

• Rocky Brands began making boots in 1932 as the William Brooks Shoe Company with an average wage rate of 28 cents per hour. In the 1960s, Rocky Brands were 100% “Made in America.” In 1960, more than 95 percent of all shoes sold in America were made in America.

• Timberland, Wolverine, and Rocky are popular brand names for this shoe market segment.

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41OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Rocky Brands, Inc.

The principal characteristics of this global value chain:1. Leather is produced in Australia and then shipped

to the Dominican Republic.2. Outsoles are purchased in China and shipped to Puerto

Rico.3. Gor-Tex fabric waterproofing materials are made in the

United States.4. Shoe uppers are cut and stitched in the Dominican

Republic, and then shipped to Puerto Rico.5. Final shoe assembly is done at the Puerto Rico factory.6. The finished boots are packed and shipped to the

warehouse in Nelsonville, Ohio.7. Customer orders are filled and shipped to individual

stores and contract customers from Nelsonville.

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42OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

Exhibit 2.7 Rocky Brands, Inc. Value Chain

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Global Challenges

• Profit margins are only about 2 percent on sales of over $100 million, while Timberland sales top $1 billion and have a 9 percent profit margin.

• After seventy years in Nelsonville, the main factory closed in 2002. At that time, local labor costs were about $11 per hour without benefits, while in Puerto Rico the hourly rate was $6; in the Dominican Republic, $1.25; and in China, 40 cents.

• The price of boots continues to decline globally from roughly $95 a pair to $85, and is heading toward $75. The grandson of the founder of Rocky Brands said, “We’ve got to get there, or we're not going to be able to compete.”

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44OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

Issues for Managing Global Value Chains

• Global value chains face higher levels of risk and uncertainty, requiring more inventory and day-to-day monitoring to prevent product shortages. Workforce disruptions, such as labor strikes and government turmoil in foreign countries, can create inventory shortages and disrupting surges in orders.

• Transportation is more complex in global value chains. For example, tracing global shipments normally involves more than one mode of transportation and foreign company.

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45OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2 VALUE CHAINS

Issues for Managing Global Value Chains

•The transportation infrastructure may vary considerably in foreign countries. The coast of China, for example, enjoys much better transportation, distribution, and retail infrastructures than the vast interior of the country.

•Global purchasing can be a difficult process to manage when sources of supply, regional economies, and even governments change. Daily changes in international currencies necessitate careful planning and in the case of commodities, consideration of futures contracts.

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46OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Issues for Managing Global Value Chains

•International purchasing can lead to disputes and legal challenges relating to such things as price fixing and quality defects.

•To extend the firm’s value chain to other nations requires an understanding of national cultures and practices.

•Privatizing companies and property is another form of major changes in global trade and regulatory issues.

•The pre-planning, response, and recovery from natural or man-made disasters—often called Disaster or Emergency Management—is another important part of value chain management.

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47OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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48OM3 Chapter 2  Value Chains© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Sustainable Value Chains

•The terms green operations, green manufacturing, and green practices are often used to describe sustainability activities that involve operations and the value chain.•Sustainability improves the organization’s perception among consumers, and improves the bottom line through reduced costs. •Sustainable practices can lead to increased revenues. For example, organizations that emit greenhouse gases like factories and electrical utilities may one day buy and sell carbon credits in a commodities-type stock market. •Many customers favor products and services that are designed and produced in a sustainable way.

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Sustainable Value Chains

OM practices for environmental sustainability:

• Designing goods and services using recyclable and environmentally-friendly materials.

• Remanufacturing.• Designing facilities and using equipment that

conserve energy.• Using electronic media and technology to reduce

paper and fuel.• Using transportation modes that minimize costs

and carbon output.• Cleaning and reusing water used for

manufacturing.

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Save a Tree—and Much More

One issue of the Quadrangle—a University of Kentucky alumni College of Engineering magazine—noted that, “This issue was printed with vegetable ink on 12,125 pounds of paper made with 100% post consumer recycled fiber. The resulting environmental savings are:

This paper publication was produced twice each year up until 2010, when it became a web-based publication only.

• 41,954 lbs of wood—a total of 145 trees that supply enough oxygen for 73 people annually;

• 53,050 gallons of water—enough water to take 3,084 eight-minute showers;

• 101 million BTUs of energy—enough energy to power an average American household for 406 days;

• 12,781 lbs of emissions—carbon sequestered by 153 tree seedlings grown for 10 years;

• 6,812 lbs. of solid waste—a total of 235 thirty-two gallon garbage cans of waste.”

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Bookmaster Case Study

1. Draw the “bricks and mortar” process stages by which hardcopy books are created, distributed, and sold in retail stores. How does each player in the value chain make money?

2. Draw the process stages for creating and downloading an eBook today. How does each player in this electronic/digital value chain make money?

3. Compare and contrast the value chain design and structure in the previous two questions from customer and management viewpoints. What are the advantages/disadvantages to each value chain design?

4. What is the role of operations in each of these value chain designs and structures?

5. What other criteria and issues are important in critiquing these two different value chain designs?