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Supply Chain Management, Value Chain,

Vertical Coordination and Vertical

Integration

Dr. Jabir Ali

Associate Professor

Centre for Food &Agribusiness ManagementIndian Institute of Management,

Lucknow 226 013

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Stages in Evolution of Food Supply Chain

P CON

P CONS&M

S&M

LR

CONP

1

3

2

T

I

ME

P=Producer

CON=Consumer

S&M= Small and Medium Intermediaries

LR= Large Intermediaries

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Complex Agricultural Supply Chain System

Mandi/ Wholesalers

Retail distribution:

Supermarkets

Grocery stores

Institutional Distribution:

Restaurants

Fast food operations

Institutions

Consumers

Processors

Producers

Input supply

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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 forconsumption

Supply Chain Management the methods,

systems and leadership that continuously improve

integration across all core business processes

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Evolution of logistics and supply chain concepts,

19602000

Term first coined by Oliver and Webber in 1982

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Developing a chain that links producers withconsumers

Each component of the supply chain is connected toother parts of the supply chain by

o the flow of goods and services in one direction,

o the flow of orders and money in the other direction, and

o 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

What is Supply Chain Management?

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Flows in a Supply Chain

Customer

Information

Product

Funds

Suppliers

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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 identifying the outline of the chain and the position of the various agents within it,

o developing the economic accounts cost, profit margins, wastages etc corresponding

to the activities of the agents involved in the chain.

PRODUCTIVEAGENT

Factors of

production

Product

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Vertical Coordination

Refers to all possible economic arrangements involved in transferring resources

between economic stageso 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 aprice 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 Transaction costs vs. physical cost

o Efficiency in chain

o Relationship

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Types of Integration

Quasi-vertical integration:

o A relationship between buyers and sellers that involves a long-termcontractual obligation where both parties invest resources in therelationship

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 itsraw 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

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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) intodistribution 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.

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Factors affecting VC

Transactioncosts

AssetspecificityUncertainty

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Transaction costs? Origin

Assumptions of neoclassical economic theory

o Perfect knowledge

o Cost-less flow of information

o No externalities

o That means transactions take place in a frictionless environment, and cost

of exchange is zero. The real world situation is different

o Imperfect knowledge

o A number of factors (non-price) influence transactions

o Information is asymmetric, and its acquisition is not withoutcost.

o Thus there are costs associated with exchange

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Components of transaction cots

Ex ante: Information costso Information search: prices, quality, identification of potential

buyers

o Screening of information: Compilation and processing ofinformation of the potential partners, prices and quality

Negotiation costso Bargaining costs

o Contract design: legal fees, notary charges

Ex post or Monitoring and Enforcement costs

o Monitoring of contract

o Enforcement of contracto Protection of rights against third party encroachment

o Transfer of goods and services: transport, storage, processing,retailing, wholesaling, losses, etc.

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Factor Affecting the Transactions in Supply Chain

Open Market

Resource Providing

Contract

Market-specificContract

Vertical

Integration

Drivers

Technological

Regulatory

Socio-Economic

Product

Characteristics

Transaction

CharacteristicsCoordination

TransactionCosts

Perishability

Product differentiation

Seasonality

Quality Variability

Safety

Branding and Packaging

Consumer Choice

Uncertainty

Reliable Supply

Frequency of transaction

Relationship specific investment

Complexity of transaction

Most

Least

Transaction Cost:Ex ante:the expenditure of time and resources for identifying suitable tradingpartner, specifying/Identifying product quality, gathering information etc

Ex post:monitoring and enforcement costs

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Factors influencing : Asset specificity

Asset specificity: lack of transferability of the asset from its intendeduse 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 salvagevalue declines.

Types: site, physical assets, human capital, temporal

Asset specificity influences bargaining power and monitoring andenforcement costs

o When market is not competitiveo When market is competitive

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

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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

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Factors influencing: uncertainty

Uncertaintyis result of information asymmetry

It increases costs of information, negotiation and monitoring andenforcement , and the firm invest more in search of honest andtrustworthy partners.

The firm prefers vertically coordinated supply chain for transactionsinvolvinguncertainty, and use various instruments such as provision ofinputs, services, credit, incentives to make it work.

Sources of uncertainty:

o Technological changes

o Unpredictable change in consumer preferences

o Random acts of nature

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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 worktogether to supply product to immediate customers?

o New question:how to record and do activities across companies, as well as acrossinternal 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 productionand distribution of our products?

o New question:how do we minimize the cost of matching supply and demandwhile 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 matchsupply and demand better, given the demand pattern?

o New question:how can we get earlier demand information or affect the demandpattern to match supply and demand?

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Shifting focus in supply chains

Shift 4: From single company, product design to collaborative, concurrent

product, process and supply chain designo 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, andsupply 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 abreakthrough 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 orsegment uniquely and provide a tailored customer experience?