Value Chains…Explained!

2019 is off to a great start for “maps of the entertainment universe”. When I was writing on media consolidation, I wanted to make one of these to help explain this crazy industry in better detail. But I doubt it would have looked as good visualization as this Wall Street Journal visualization I saw on Twitter last week:

WSJ Map of Universe.png

Source: Wall Street Journal

What I love about that image is that it conveys multiple pieces of information in a 2D fashion. That’s really hard to do. That’s the gold standard of charts/tables/maps. This image conveys the names of companies, types of entertainment they offer, who competes in multiple areas and who doesn’t. Good job.

But while I love that lay out for what it does, it still has limitations. Mainly, you don’t know the directions of the various branches. Are they all separate types of services or are they interrelated? Are some companies distributing the other types of entertainment? How do they relate? How distinct are live TV, ad-supported and sports content anyways?

So while that visualization is good, it is still incomplete. (To be clear, I liked the image. A lot.) I want to build on that chart and others, but to do so, I need more tools. My goal is to explain the business of entertainment, and to do that requires first explaining some of the tools I plan to use. These tools explain not just what the companies are competing in, but how they compete and relate to each other.  Today, I’ll explain the “value chain; tomorrow, I’ll explain a different tool. Then we can build our own map of the entertainment universe. 

Note before I start: These two tools are both super complicated. My explainers do not do them justice. I mean chapters and chapters in strategy text books have been written on this. And I felt I needed to reread those chapters in my still saved text books as refreshers before writing today. So at some point I’ll make a reading list if you’re interested.

Value Chains

Let’s start a series of shapes. 

A shapeOkay, that didn’t help. Let’s add three words to make the simplest value chain imaginable:

Image 1 Simplest

The “chain” here is the journey of a product to a customer. Essentially, someone makes a good. They sell it to a store who sells it to a customer. If each step “adds value”, that’s your “value chain” in action. (What if someone doesn’t add value? Well, they’re still here in the value chain. That’s what we call it.) Here’s a pic from my strategy text book, just vertically rotated:

IMG_4437

Same really simple principle.

In my experience, good strategy starts with this core tool. Even if you think you know your industry top to bottom, back to front, you should still use this tool. First, it’s a good refresher to challenge how your industry has changed over time. Second, as new industries emerge, you can use this tool to understand their emerging value chains. In my previous role, when I dug into a new business opportunity, I would sketch out an initial value chain and use that to figure out how to research the new industry. It never failed to generate some insights.

(An aside, yes, I’m explaining a “strategy 101” concept here. The basics of industry analysis. Some super smart executives definitely don’t need me to teach this to them. If you’re one, skip ahead. That said, at three different companies, I never saw this tool used. Even as business models changed rapidly. It’s a basic yet powerful tool, like value creation. And I doubt business affairs, creative development or production executives have ever seen it.)

The value chain is a little tricky for digital goods. It started its life as a tool for manufactured goods. You know, the hey day of American might and exceptionalism in the 1960s. So I’m going to explain the tool with a manufactured good. Trust me, we’ll get to digital video.

Let’s use a delicious example, potato chips. This will pair nicely with my example for value creation, craft beer. Throw these two articles together and you got a party. The first step? The potatoes:

Potatoes

How do farmers add value? Well they grow a crop that wouldn’t exist if they didn’t. Harvesting the raw supplies. But now we need someone to come in and turn potatoes into something:

Potatoes and ManufacturersThe manufacturers add value in two ways. First, by turning potatoes into chips, they make a tasty treat. Then, they also pay for the marketing to make you want to eat that tasty treat. But potato chip companies like Frito-Lay don’t own all the stores. And often don’t have the distribution to sell everywhere. So they use:

Full Value ChainThe distributor has the logistic excellence the factory doesn’t to get the chips out there and the store has customer service and variety of products. (Again, in an ideal world.)

You can see that you start with potato farmers, who sell to potato chip manufacturers. They sell to distributors or wholesalers who sell to stores. At each level, they take their margin, so that a potato sold for say $0.25 becomes a $3.99 bag of chips at the store. In an ideal world, each level is “creating value” for the end consumer. The potato farmer creates a potato that wouldn’t exist otherwise, the potato chip manufacture transforms it to make it delicious using special techniques. We need one last piece though.

True Full Value ChainI like adding customers even though it is redundant in someways because it clarifies if the end of a value chain ends in customers or a business. And I always believe in reminders of the value of the customer. 

I’ll make one last point. I mentioned that the problem with the Wall Street Journal article was that it didn’t explain the relationship between the layers, and the value chain doesn’t either. What it does is explain what pieces feed into what to make a final product. So we need to start adding some numbers to get this thing rolling. And since I mentioned value, ideally we’d fill out a chart like this:

Value Creation Chart

Again, this is a vertical form of the horizontal value chain from above. (I’ll explain tomorrow why I left it horizontal.) But now if you can estimate the “willingness to pay” for customers, and you know the values of potato, then you can figure out all the prices and see who is capturing what value at what level. If I knew the actual numbers, I’d fill this out, but don’t want to lest I get something wrong. But you can see where you would put the numbers in. 

The next key insight, though, comes from using those numbers to see who captures the biggest share of the pie. (Technically, PIE, but do not have time to explain that in one article. That’s some math.) If one level captures an inordinate amount of the value, well, they are pretty powerful. 

Well, how do we explain that? With another tool for tomorrow.

Other Ideas/Notes

First, if you search “value chain”, or go to Wikipedia, you usually get this phrase tied to Michael Porter’s “value chain”, which is about a company internal value chain. That is specifically not how I am using it and again my professors teaching me were using value chains to discuss larger industry analysis. Which is how I use it. (And we’ll get to Porter tomorrow!)

That said, I do love always thinking about creating value and the similarities between a company and an industry. And this type of value chain analysis can be insightful. For entertainment, a development exec adds value by finding a great project, business affairs gets the talent signed for good prices, a production exec adds value by producing it on time and on budget, finance gets the money on time to pay for everything, and then marketing gets customers to pay for it. 

Second, value chains don’t always have one straight line. You can sell to multiple distributors, with their own value chains and outputs—say liquor stores or super markets or online—or have multiple suppliers—how many things go into a car, for example? But still, understanding them at a high level is usually useful. 

Why I’m Unveiling These Tools Now

I don’t like referring to strategic concepts that are even slightly advanced if I haven’t explained them. And on Thursday, I’m going to need to use the value chain to explain my next HUGE analysis article. (Analysis articles are where I use numbers to draw definitive conclusions. Like my series on Lucasfilm-Disney Acquisition, M&A in entertainment or the Pac-12. Just look to the column on the right for ideas.) I’m not telling what it is, but it involves dragons, orcs, talking lions, white walkers, rings and multiple media companies.

Also, the definition of digital video”, it seems to me, needs a better explanation. Understanding the value chain helps get there. The roll out of Apples Plus/TV product two weeks ago seems to necessitate better explanations of digital video’s value chain.

Oh, and last week, I mentioned value chains with agents! So if I see value chains all over the place, and they need explaining, well, I’ll help out.

  1. […] trouble with value chains—which I unveiled Monday—is that they don’t stay the same forever. They are constantly changing. Disruption, […]

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