Going Up The Value Curve A Guide for Indian Companies in International Business
Going Up The Value Curve A Guide for Indian Companies in International Business Managerial leadership in modern business environment Increased complexity, contextual unfamiliarity and knowledge intensity in firms today Necessity of leveraging managerial leadership qualities .

The Issue
Do you run a company based in India that is active in the international arena and frequently come across articles in magazines that advise companies to “go up the value chain”? Do you wonder why you should do so when your margins are healthy and your return on invested capital is adequate? While business has become tougher, customers more choosy and competition intense, do you wonder whether attempting to create a global brand makes sense? Or if you run a software services company, whether entry into the product space or consulting is worth the risks involved?
If so, read on. In what follows, we look at this issue from both conceptual and practical perspectives. We seek answers to the following questions: What does going up the value chain mean? When does a company need to do so? Does every company need to traverse this apparently risky path?

Basic Terms & Concepts
The term “value chain” is typically used to describe the series of processes or activities through which a business transforms its inputs into the products or services that it sells. Thus in a manufacturing company, the value chain would include purchase of raw materials, their processing through various production operations, finishing processes, testing and quality checks, and finally sale of the finished product through the sales function. Other processes like consumer research to understand customer needs, product definition and product development typically precede the production process, though they would be undertaken separately for each unit of output only in the case of custom-made products.
The decision on which activities in the value chain to undertake within the boundaries of the firm is a strategic choice. Successful companies tend to focus on those parts of the value chain in which they have the strongest competence (and can hence add the most value). Thus, Nike concentrates on product design and marketing, and outsources manufacturing to qualified suppliers based in countries that enjoy low labour costs. On the other hand, a company that sees its competence primarily in manufacturing may choose to operate as a contract manufacturer to produce products to the designs of other companies.

Given this common conceptualization of the value chain, going “up” the value chain has little meaning. What is actually meant when there is talk of going up the value chain may be better described as “going up the value curve.”

In any industry, there are alternate ways of competing or alternate business models, each involving different gross margins and levels of technical and managerial complexity. These may be arranged sequentially in increasing order of gross margin to constitute a value curve. Consider the case of the pharmaceutical industry (See Figure 1). At one end of the value curve, you can adopt a business model of producing bulk drugs. This is almost like being in the fine chemicals business. Gross margins are low and the complexity of the business (in terms of the technical and marketing challenges) is also low. A second model that offers slightly higher margins but also a higher degree of complexity is to produce and sell generic drugs. A third model is to make and sell formulations. A fourth is to create new drug delivery systems for existing formulations based on in-house research and development. And the most complex model (with the highest gross margins) is the model adopted by the large research-based pharmaceutical companies whereby they seek to create new blockbuster drugs in different therapeutic areas.

There are a number of important points to be noted about the value curve framework.

• There is nothing to suggest that there is a natural progression from one business model on the value curve to another. In fact, if anything, the companies adopting different business models compete principally with other companies using the same business model in so-called “strategic groups.” Each company has to make a choice of which model best suits its own capabilities.
• Companies may experiment with different models till they settle with the model that best suits them
• The risks involved in going up the value curve are significant – for example, at the top end of the pharma value curve, there is a wave of mergers and acquisitions taking place as companies struggle with the challenge of finding the next blockbuster drug, at a time when the pharma innovation engine appears to be losing steam.
• Developing the capabilities to go up the value curve is a non-trivial exercise, particularly because this involves access to tacit knowledge that cannot be acquired easily.
• Being a hybrid, i.e. straddling different business models within the same organization, is difficult because the organizational requirements of different models vary.

Value Chain Value Curve
Represents the sequential steps in converting firm’s inputs into products or services for a given market Represents different configurations of product/ service scope within the given product market Different stages can be selectively outsourced, but all steps have to be performed to provide a complete product offering to the market Can selectively compete in the given market with one configuration of product/service There is no automatic correlation between how the different stages are performed and the profit margins (this may vary across firms) There is an implicit hierarchy in the value curve- the configuration at the higher end of the curve is expected to yield higher margins than those at the lower end

Rationale for Ascending the Value Curve
If we assume that the fundamental objective of a business is to maximize shareholder value, what we are essentially interested in is finding a business model whose returns exceed the cost of capital. Every company incurs certain costs in providing goods or services to its customers. In return, customers pay the company a price for the product or service. What price the customer is willing to pay depends on a number of factors such as the price charged by competitors, importance/criticality of that product to the customer, the maturity of the product, the price of substitutes, intangibles such as the prestige associated with using the product, etc. For the producer, the challenge is to drive a “wedge” between the cost it incurs and customer “willingness to pay” so as to ensure a series of net positive cash flows. For most companies, the cost dimension is easier to address because many cost-related variables are within control. Quality management techniques, business process reengineering, value engineering and improvements in the supply chain offer tools to improve cost performance that can be implemented through internal actions. On the other hand, addressing customer “willingness to pay” involves competitive differentiation and investment of resources in marketing and brand building with more uncertain outcomes.

To compound this problem, customer “willingness to pay” is subject to significant threats. Customers try to push down prices as they become more familiar with the product or service, gain better knowledge of the producer’s costs, and as new producers enter the market with “me-too” products. Branding, product differentiation, proprietary technologies (backed up by patents or other forms of protection of intellectual property) and long-term contracts within the same business model are the typical defences against this pressure. When these defences do not work, companies look to going up the value curve. However, this is difficult because moving to a higher position on the value curve involves the possession of a different set of capabilities, and these are often not easily acquirable. Even if they are acquirable at a reasonable cost and within a reasonable time frame, they may be difficult to integrate with the existing capabilities and business processes of the company. Moving to an adjacent position on the value curve may be worth the costs and risks involved, but moving across multiple positions (e.g. from bulk drugs to new drug development) is substantially more difficult.

Are there Alternatives to Going Up the Value Curve?
Fresh thinking about the existing positioning of the company within the same generic business model can help a company delay if not avoid the need to ascend the value curve. Some of the key dimensions of thinking here are choice of customer segment and how you present your value proposition to the customer. Customer willingness to pay can be enhanced by choosing the right customer segment. Dell Computers provides a good example. Though most studies of Dell focus on its direct sales approach, there are other important elements of its business model. For example, the Dell computer, made to the customer’s specifications, is completely assembled and tested before it is dispatched. For corporate customers, this could even include different application software packages. Thus, apart from giving customers the ability to choose a configuration that suits them, Dell enhances reliability and quality. This enhanced quality and reliability matter most to business customers. Since businesses buy computers to enhance productivity, they are also willing to spend money on maintenance. Besides, most businesses have the internal expertise to be able to decide on what computer (configuration, software, etc.) suits their needs best, so they do not need the advice of a computer re-seller. While its direct sales model allows Dell a lower cost structure than its competitors, by targeting large business customers Dell does not have to sacrifice much on prices.

Before you attempt to change your business model or position on the value curve, it is useful to examine how you are presenting your value proposition to your customers and whether there are alternate ways of presenting your services that would enhance customer willingness to pay. Several service companies find that they are creating substantial value for their customers, but are able to capture a very small part of this because of their practice of pricing on a man-hour basis. Moving to modes of pricing that allow greater value capture such as fixed-price contracts can help. But to do this effectively, the company needs a higher level of sophistication such as better estimation of project time and costs, and a more thorough understanding of the customer’s costs and benefits. It also involves targeting a different set of customers (decision-makers) in the client organization for whom value is more than cost reduction. This change in pricing policy or value proposition does not by itself constitute ascending the value curve, though it results in better value capture if successful.

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