Pivoting within the Value Chain: Vanderbilt, Rockefeller, Carnegie and Beyond

Brief History: 
American culture is built on the backs of Cornelius Vanderbilt, John D. Rockefeller, Andrew Carnegie, J.P Morgan, and Henry Ford, among others. These are the men that helped build America and transform it into what it is today. How were all of these early tycoons all so wildly successful one may ask? Some may say timing had everything to do with it. Others luck. I believe as we begin to peel back the onion, examining these men from a historical business context, one striking reoccurring strategy runs deep through them all. They were all adaptable, hyperopic thinkers that dominated one industry and moved to the underdeveloped and underserved segment in the value chain where expectations were not being met and installed capacity had not met demand.

Cornelius Vanderbilt started his business adventure as a regional steamboat entrepreneur actively working in the Boston, Albany, New York, California and New Jersey areas. He soon discovered railroads were being built to transport goods from these coastal areas inward toward the west. Because Vanderbilt served so much of the market by the 1850s he was able to compete directly with New York, Providence and Boston Railroad (Stonington) by dropping fares, but he had much larger plans than a price war. Vanderbilt was able to gain control of the company as
the stock dropped in value and took over as president shortly after, the first of many railroads he would control. He began to sell his interests in steamboats and continued to buy railroads, eventually ending up with a near monopoly on the Northeast freight.

Vanderbilt was able to adapt to change, seeing a potential threat as an opportunity. He was able to shift upstream to the underdeveloped segment (from steamboats to railroads), and underserved segment in the value chain where expectations were not being met and installed capacity had not met demand.

Vanderbilt moved from the point of inbound logistics to the point of outbound logistics, understanding the common theme of westward expansion and that he belonged to the transportation industry, not just the shipping business.

John D. Rockefeller saw the oil revolution unfolding, electing to build a refinery instead of joining the wildcatter’s exploration and drilling endeavors. Rockefeller was moving towards where the puck was going, not where it was. He began refining oil into kerosene, chasing his vision to light every home in America and beyond. He made a deal with Vanderbilt (as well as the other railroads) for freight rebates on both his own shipments and his competitors, consolidating the Cleveland refineries in the process. The railroads knew how important the oil freight was, allowing themselves to be played against each other in the process. John D. placed himself in the position of the bottleneck and began to use it to its full potential. In the meantime railroad mania had been unfolding (reason behind the panic of 1873) and John D. Rockefeller knew that the railroads had been overbuilt. He used his muscle (50%+ of the railroads freight volume) to enact further price cuts on his freight while receiving rebates from his competitor’s freight. John D. was able to control over 80% of the kerosene market in the U.S, but the birth of the automobile motivated him to pivot. John D. moved upstream in the operations segment, beginning to refine gasoline for America as Edison began wiring American houses with electricity and constructing the central station generation facility, an obvious threat.

Carnegie started in the railroad business and moved upstream into iron working, supporting the railroad industry through the service segment in the value chain. He made steel for railroad lines and bridge girders while vertically integrating all raw material suppliers. It was the birth of the Bessemer converter (new rolling process) that allowed Carnegie to leapfrog early competition. He brought production time down from two weeks to 12 hours and by the later 1880s, Carnegie Steel was the largest producer in the world.

Michael Porters Value Chain
value chain

Elon Musk announced he would be building a Gigafactory to support lithium ion battery production the day after he also opened all current Tesla patents for use to the public. This is another example of moving to the underdeveloped and underserved segment in the value chain where expectations are not being met and installed capacity has not met demand.

 

Owners or investors should examine their strategy from a holistic perspective, analyzing what value is available to the value chain and how it can be improved going forward. Are there bottlenecks that can be improved on? Bottlenecks are usually waiting points reliant on a previous input that has not been fulfilled and within the operations, inbound and outbound logistics segments.

Apple Teardown and Supply Chain Value

Below is a graph representing the estimated costs of an Apple iPhone by component. It seems as though an Apple iPhone 6 Plus will cost $242.50 in intermediate goods. We need to also include Foxconn’s gross margins of roughly 12%, brining Apples intermediate material cost to about $272.

The selling price of the phone is $860 in Canada for the iPhone 6 Plus, or roughly $780 USD. Looking at these numbers we may jump to the conclusion that Apple is making over $500 per phone sold, but this is misleading. Apple must also pay for transportation and labor costs, post sale services (warranty), capitalized R&D, marketing, advertising, sales, administration etc. while selling at a wholesale price to distributors who in turn sell it for a mark-up. Apple uses over 200 suppliers, all of which earn a markup on components provided.

 tear down apple

The point being, there are many different levels in which inputs of value are provided and revenue shared by many different players working together. Apple is a world-class company and has diversified the suppliers it uses as demand grows, standardizing components and auditing production factory’s for both TQM and efficiency reasons. Where can Apple improve? Where can Apple remove bottlenecks that are inhibiting value and add ones that create value? We see that Apple currently believes IT is moving in a general trend towards new payment transaction technology and digital healthcare diagnostics, both underserved with minimal expectations. Would vertical integration of hardware suppliers be beneficial or should they continue the organic software build out? Apple nonetheless dominates the value chain.

Hindsight is 20-20, How Can We Forecast Value Chain Movement?

Divergent problem solving and thinking about how industry segments intertwine as well as where the convergence is likely to take place, using history as our guide, is a starting point. Divergent problem solving is exploring many possible solutions and picturing the scenarios of each but within a limited scope, much like chess or poker. It is best to probe many alternatives opposed to probing one or two in great depth.

For example, the solar industry went through a point of manufacturing saturation where panels were differentiated primarily by price as standardized supply flooded the market. Both the manufacturing point of panels in the value chain as well as the primary service of installing the panels have become commodity businesses with the odd exception. There are now three areas within the value chain that are underdeveloped, underserved, and have low expectations going forward.

1) Pre and Post Installation Services (Energy usage monitoring and evaluation systems)

2) Storage, distribution and battery technology (Maximizing capacity of energy that can be held and minimizing energy loss)

3) PV panel conversion efficiency (new technology)

Installed capacity versus demand

We can see using the example above that SolarCity is currently the only integrated provider and is moving upstream aggressively to alternative 1 while Chairman Elon Musk takes Tesla into alternative 2. The spread between demand and actual performance for battery technology is massive, a clear bottleneck within the value chain framework. Pre and post installation services are also actively being sought by consumers that are moving off the grid, using renewable energy sources or simply looking to save money through subsidies.

What is underdeveloped?

Underdeveloped meaning very little competition, a small market that is growing quickly and where quality is poor. Competitors are not enticed by below average ROIC (above average does not exist yet) and when competitors do begin to enter the market, the intensity of rivalry is mitigated by the capacity-demand spread. When installed capacity meets or surpasses demand and the quality demanded begins to continually rise, the market is likely developed.

Where is the Industry Currently?

Using Porters 5 forces framework and adding growth, size of the industry and complements is a great way to conceptualize the “starting state.”

  • Size of the industry?

  • Growth of the industry?

  • Substitutes and compliments?

  • Bargaining power of suppliers
    – Concentration of suppliers (dominated by one or two large companies or spread out?), are the goods supplied critical to the buyer’s success? Are substitutes available? Is the product standardized? Is forward vertical integration a plausible threat?
  • Bargaining power of buyers
    – is a large portion of industry output bought by a few individuals? Are switching costs high or low? Is the industry product standardized? Is backward vertical integration a plausible threat?
  • Intensity of rivalry
    Numerous or equally balanced competitors? Growth of the industry? Cost structure (high fixed costs and storage?) Low switching costs? Exit barriers? Reliance on performance or strategic stakes.
  • Threat of new entrants
    Barrier to entry, economies of scale, product differentiation, capital requirements, switching costs, access to distribution channels, expected retaliation, government policy, cost disadvantages independent of scale.

 

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