To what extent does the concept of power contribute to our understanding of supply chain dynamics

University Degree Business and Administrative studies

To what extent does the concept of power contribute

to our understanding of supply chain dynamics?

Supply chain management is a newly developing area of business competence which aims to explore the impact that each supply chain has upon a business’s rents and manage them in an effective and productive manner. A supply chain is defined as “the series of functionality stages that use various resources to transform a raw material into a finished product or service and to deliver this product or service to the ultimate consumer.”

Bearing in mind that the area of competence is relatively new not many different schools of thought have had time to develop. Up to now, three prominent schools have stood out; lean, agile and interactions schools with the lean supply school dominating literature. Currently research is being carried out by Andrew Cox et al, which is aimed at assessing the extent to which the concept of inter-organisation power can bridge the gap between these schools.

One aspect that all of these schools have in common is that all businesses are working towards gaining part, or all, of the surplus value from every transaction in which they partake. The surplus value is the difference between the costs that the vendor incurs when making the products for the buyer and the price placed upon the product by the buyer; as illustrated by the diagram below;

200 250 300 350 400 450 500 550 600 650 700 750 800 850 900 £

Every firm is interested in gaining this surplus value and improving on their value for money proposition. Value for money is not solely based on cost, it is also established

on functionality and has a set equation that can be used to calculate it;

Value for Money = Functionality

Cost of Buyer

Supply chain management is about managing these exchanges in order to align the internal and external processes in an appropriate manner so that the business will gain the surplus value and improve their value for money proposition. Thus far the strategy that has been suggested to do this has usually been the lean supply, sometimes referred to as the efficiency theory. It started to appear when research was conducted by Womack, Jones & Ross (1990) in order to understand the phenomenal success of Japanese industry in the 1970s and 1980s. The foundational principle of the lean supply school is that competitive advantage will be derived from collaboration throughout the supply chain in order to reduce various forms of waste resulting in the delivery of outstanding value to the end customer. It is argued that everyone partaking in this ‘partnership’ should benefit, thus resulting in the surplus value having to be shared, on either a more or less equal basis.

However, despite the phenomenal amount of literature that has been published on this theory it has recently gained much criticism. Many firms have been unsatisfied with the level of benefits in terms of cost reduction, quality improvement or innovation. Cox et al, in the book ‘Power Regimes’, suggested that the criticisms fall into two broad categories; the problem of competitive imitation and the problem of appropriateness. Michael Porter’s 1996 observation that a sustainable competitive advantage cannot be built upon easily imitated tools and techniques designed solely to enhance a firm’s operational efficiency endorsed competitive imitation. It is obvious that when one firm makes improvement that other firms will follow with the same improvements, thus competitive advantage will be dispersed and the lean efficiency theory is flawed. This is a prime example of why profits, defined as “earnings in excess of a firms cost of production”, tend to graduate towards zero because more and more firms enter a successful market resulting in increased competition thus driving down the price due to imitation. The problem of appropriateness has not widely been addressed as the authors of lean supply thinking have taken the view that supply chains do not vary in type and their strategies are appropriate for all supply chain circumstances. Two main problems arise from this approach. One, that it does not help the practitioners who cannot use lean thinking and, secondly, it has become clear that there are a very many situations where partnerships and integrated supply chain management are difficult to apply.

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In order to help those practitioners who cannot use lean supply thinking, it is essential to understand why lean thinking cannot be applied to the supply chains, not simply that it cannot be done. When examining the recent attempts to codify supply chains one can see that they have been descriptive. There are a vast number of unique properties to supply chains, thus a descriptive classification is not appropriate. However, it has been recognised that supply chains have a certain set of rules embedded in their structures with the basic unit of analysis being the dyadic power relationships between ...

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Buyer Dominance
Supplier Dominance
Buyer-supplier Interdependence
Buyer-Supplier Independence

It has been proposed that in order to understand supply chain power structures one must begin with an in-dept analysis of these four types of relationships. The foundation of this argument is that supply chain power structures are best explained and analysed in terms of the dynamics of multiple dyadic interactions, which are themselves touched upon by the market-based power circumstances intruding on buyers and suppliers at their position in a supply chain.

In previous literature, power has not been totally overlooked, just discounted from analysis for a number of different reasons. The main author on these reasons was Williamson (1995). The first reason that was given was that power was frequently poorly and tautologically defined because it was used only to describe ex post rationalisation rather than explaining why the firm actually gained the power. Williamson argued that the risk of the buyer becoming dependent on a supplier was not a function of power, rather a result of bad management. Ronald Coarse gave a further reason in that the lean supply school was based on conventional economics, thus believed there was a price mechanism present in the market which was capable of perfectly co-ordinating the provision of goods or service therefore no further authoritative power was required.

However, many academics believe that power has a great part to play in supply chain dynamics and research is currently being undertaken by Cox et al as to the extent of power regimes influence upon business exchanges. I hope to demonstrate that power has a large part to play on influencing supply chains and aiding practitioners to carry out a successful management strategy.

In order to combat the problem mentioned earlier in that profits often tend towards zero power can be used as it is based on the idea of rents rather than profits. Rents are defined as “earnings in excess of the firm’s costs of production that are not eroded in the long run by new market entrants”. It will be shown that power is a key tool in order to exploit to the market to acquire rents.

Perhaps the most widely used definition of power was given by Lukes (1974), “the ability of one actor to affect the behaviour of another actor in a manner contrary to the second actor’s interests”. However, I prefer a more detailed approach to the definition; “the ability of a firm to own and control critical assets in markets and supply chains that allow it to sustain its ability to appropriate and accumulate value for itself by constantly leveraging its customers, competitors and suppliers”.

The key to the latter definition is ‘critical assets’, which are characterised as something which has high utility and relative scarcity. In real terms this means that if something is desirable and not widely available in the market the demand will be higher, thus the supplier will hold more power and be said to be in the buyer dominant stance. This critical asset can be held by either the buyer or supplier, jointly or independently.

Resource utility has two contributing factors, namely the operational importance of a particular resource in the business and secondly, the resources commercial importance to a firm’s overall revenue-generating activities.

The operational importance is the question of whether the good or service is indispensable which in turn relates to the number of possible substitutes available in the market. Many resources have relatively low operational importance because their absence, or replacement, would not prevent a firm from delivering its product. Operational importance is viewed slightly differently from a buyer’s perspective as the key resource in which a supplier is interested is a buyer’s expenditure. There are two factors which the supplier is interested in, firstly they will look at the ratio between the buyers expenditure and the revenue generated from that area of sales. Secondly, how regular and predictable the buyer’s expenditure will be in order to allow them to make a credible commitment to future investment in research and development and capital equipment.

It is not sufficient for the good or service to simply hold high operational importance in order to give it high utility value. A large majority of businesses are multi-business entities, earning rents from many different supply chains. Different supply chains contribute differing amounts to a business’s revenues and profits. Those areas of business which represent the bulk of the firms’ revenue generating activities are characterised as primary activities, with all others being named support activities. A diagram has been devised in order to determine the relative utility of a resource. For example for a resource to have a high utility for a particular buyer or supplier it must be both operationally and commercially important, thus it is more likely to give the firm power.

The critical asset is also characterised by its scarcity, which is essentially a function of its imitability/substitutability. It follows that if a product is easily imitated that it will be readily available from the majority of companies, thus not giving it a critical asset description. The primary question to be answered is how scarce are the resources for either party of the exchange? in other words, is it a monopoly, oligopoly or another type of market. However, we must go beyond this basic analysis and seek explanations for imperfect imitability or imperfect substitutability of certain resources. The idea of substitutes is already granted much significance in academic writings, as was shown in Porter’s (1980) ‘five forces’ model. Contrary to Porter’s analysis, the majority of resource-based worked has focused on the issue of imperfect imitability.

Rumelt (1984-1987) made a very important contribution by developing the idea of isolating mechanisms, which impede competition and allow a firm to earn rents. Rumelt describes two main classifications of isolating mechanisms. Firstly property rights to scarce resources and various quasi-property rights in the form of first-mover advantages and the second category includes information impactedness, buyer switching costs, reputation effects, buyer search costs, communication good effects and economics of scale. There is much more that can be said on this topic, however space does not permit so I shall move on to discuss how resource scarcity can also be a function of information asymmetry between firms involved in a vertical buyer-supplier relationship.

Information asymmetry relates to the condition of bounded rationality and is often the key part of power imbalances between buyers and suppliers. Information asymmetry is based on the distinction economists draw between public and private information. Public information refers to information which is generally obtainable and private information is hidden knowledge and can only be obtained by the other contracting party through expenditure of significant time and money, if at all. Problems can arise when a firm with superior knowledge chooses to distort the other party’s perception thus making their good appear more scare than it actually is. This occurs at a pre-contractual phase of a transaction and is known as adverse selection. Post contractual opportunism is known as moral hazard. Both these situations make it clear that firms have bounded rationality, in that they intend to make a rational decision though they do not have the time, money or resources to make an entirely rational one, thus they often satisfice for goods readily offered to them. It is here where the suppliers use their superior knowledge act opportunistically; self-interest seeking with guile.

A perfect example of a firm which suffered from opportunistic behaviour is IBM with its dealings with Microsoft. IBM needed a quick-fix solution for its PC business and went to Microsoft though allowed them appropriate value by acting opportunistically which could and should have remained with IBM. IBM presumed it was in a buyer dominant position thus contracted openly with Microsoft creating an adversarial arms length relationship. When IBM’s operating system took longer to enter the market than expected it allowed Microsoft to supply to IBM’s competitors products to compete with IBM’s, thus reducing the value and power held by IBM. It was this foresight and understanding of the opportunity before them and understanding of the power in the market that has helped Microsoft to become the giant it is today.

If Microsoft were not to understand the power that was within the market then it is with no doubt that they would not be in the position they are today; the Worlds’ number 1 for computer operating systems.

One must also not forget that you must examine the power regimes at a network level. I have only examined power at a dyadic level, though one must examine the flow of value through a whole chain of supply chains in order to create an effective strategy. This is because who gains the value in one dyadic relationship affects who gains the value in exchanges throughout the chain. If the value has not been passed in the direction to which you are then the value is not there for you to attain.

Ultimately power is determined by the ability to hold the critical asset within a market which in turn determines what position one holds within the supply chain; whether it be one of dominance, interdependence, or independence.

(Word Count = 2,352)

Bibliography

Cox, A Sanderson, J. and Watson, G (2000) Power Regimes
Cox, A. et al (2002) Supply Chains, Markets and Power
Cox, A. (1999) ‘Power, Value and Supply Chain Management’, Supply Chain Management, 4 (4)
Watson, G., Cox A. and Lonsdale, C (2002), Understanding the Limits to Management Action in Supply Networks, British Academy of Management Conference