Value capture in hierarchically organized value chains

• DOI: http://doi.org/10.1111/jems.12278
• Author: Alexander Hoffmann,Joachim Henkel
• Date: 01 April 2019
• Published date: 01 April 2019

260 © 2018 Wiley Periodicals, Inc. wileyonlinelibrary.com/journal/jems J Econ Manage Strat. 2019;28:260–279.

Received: 17 August 2016 Revised: 25 April 2018 Accepted: 19 June 2018

DOI: 10.1111/jems.12278

ORIGINAL ARTICLE

Value capture in hierarchically organized value chains

Joachim Henkel Alexander Hoffmann

TUM School of Management, Technical

Universityof Munich, Munich, Germany

Correspondence

JoachimHenkel, TUM School of Management,

TechnicalUniversity of Munich, Arcisstr.21,

80333Munich, Germany.

Email:henkel@wi.tum.de,

alexander.hoffmann@wi.tum.de

Abstract

We study how the structure of negotiations in a value chain affects the distribution of

value among its members. To this end, we generalizet he Shapleyvalue and the core to

hierarchical bargaining situations. While the core yields no concrete predictions, the

Shapley value analysis suggests that positions most conducive to value capture are

those that allow to realize large complementarity gains. If the game exhibits “super-

complementarity,” then it is advantageous if a firm's negotiation partners are grouped

into clusters. Using examples from the aircraft and white goods industries, we assess

whether the firms’ actions are consistent with model predictions.

KEYWORDS

industry architecture, modularity, negotiations, Shapley value, value capture

JEL CLASSIFICATION:

C71, D21

1INTRODUCTION

The past decade has seen significant structural shifts in the value chain of large commercial aircraft. Airbus and Boeing, tradi-

tionally integrators of a large number of aircraft components, have handed over responsibility for large sections of the aircraft

to select suppliers for the most recent programs of the A350 and the B787 Dreamliner. These so-called mega suppliers not only

design and integrate the awarded sections but also manage the value chain for the respective system. Concomitantly, firms that

once dealt directly with the original equipment manufacturer (OEM) have been moved to a lower tier where they now negotiate

with and supply to one of the mega suppliers. For example, B/E Aerospace, which supplies oxygen systems and used to deal

with Airbus directly for earlier programs, now supplies components for the A350 program to and conducts all related price

negotiations with mega supplier Spirit AeroSystems.

Arguably, such changes to the value chain should affect the distribution of value among the participating firms; yet, the

extant literature on value capture largely focuses on a firm's replaceability. According to this logic, a favorable position with

respect to resources and market structure may put a firm in a “bottleneck” position in an industry and, more specifically,

in a value chain (Baldwin, 2015; Iansiti & Levien, 2004; Jacobides & MacDuffie, 2013; Jacobides, Knudsen, & Augier,

2006; Morris & Ferguson, 1993; Pisano & Teece, 2007). Although existing studies have greatly enhanced our understanding

We thank Carliss Baldwin forjoint work on related topics that provided invaluable inspiration for this study. Weare also grateful to two anonymous reviewers,

Michael Cusumano, Jan Göpfert, Jerry Green, Marco Iansiti, Reddi Kotha, Anita McGahan, Ron Perez, Reinhard H. Schmidt, and James Sebenius, reviewers

for the Academy of Management Meeting and the TIE Conference, as well as participants in seminars and workshopsat Cass Business School, ETH Zurich,

European School of Management and Technology, GEABA Symposium, INSEAD Singapore, Judge Business School, London Business School, Open and

User Innovation Workshop, Singapore Management University, TIE Conference, TIME Seminar at LMU and TUM Munich, and Warwick Business School

for fruitful discussions and helpful comments on earlier drafts of this article. We thank Deborah Grey for editorial support, and our interviewees for being so

generous with their time.

HENKEL AND HOFFMANN 3

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of how industry architecture affects value capture through the intensity of competition in the various segments of a value

chain, more fundamental variations in the architecture of value chains are ubiquitous, as illustrated by the aircraft example.

Such changes to value chains, implying that its members are rearranged, are not considered in the existing literature. In fact,

the meaning of “architecture” as describing the structure of the value chain and the linkages among its constituent firms is,

so far, largely unexplored. The study by Erat, Kavadias, and Gaimon (2013) is a notable exception; however, it focuses on

competitive differentiation and the benefits of outsourcing the integration function rather than on effects of the structure of

negotiations.

The present study—based on and extending the work by Hoffmann (2015)—addresses this gap. Focusing on the value chain

as the unit of analysis, we argue that the division of value between its member firms takes place in a hierarchy of negotia-

tions. Typically, the manufacturer of a final good will negotiate with its tier-1 suppliers, which, in turn, will negotiate with

their respective suppliers. We refer to the bargaining structure of a value chain to describe which of its members negotiate

among each other in the various stages and branches of the value chain, and how these individual negotiation processes are

linked.

A simple example of three firms shows how bargaining structure affects value distribution. We assume that costs are zero

and that all firms are essential, in the sense that each firm's absence would reduce the overall value captured by the remaining

firms to zero. There are two possible bargaining structures, nonhierarchical and hierarchical. In the nonhierarchical, or linear,

structure, all three firms bargain jointly on the same level. The most plausible prediction of payoffs, in line with the Shapley

value (Shapley, 1953), is that each firm obtains one-third of the total value, forreasons of symmetr y. A hierarchical structure, in

contrast, is given if one firm bargains on the top level with a representative of the other twofir ms (that together form a “cluster”),

which subsequently negotiate to split among each other the value captured bytheir represent ative.The two top-level negotiators

are symmetric in that both are essential and have zero cost; therefore, they should split the availablevalue evenly. This outcome

may appear counterintuitive, because one of the negotiators represents two players. However, the two-firm representative can

threaten only once to withdraw from the negotiation, just as can its counterpart. Furthermore, the single firm may point to the

possibility that it could split its position in two, referring, for example, to two process steps or two components of its input.1

Thus, what one perceives as an intuitive outcome of the top-level negotiation depends on the point of reference. This may be

either a situation with three firms, two of which are represented by one negotiator, or a situation with two negotiators, one of

which has an internal structure. With the latter reference point, an even split on the top level is intuitive. Research on cognitive

biases in decisions on how to allocate budget between divisions of a firm suggests that the latter reference point is indeed the

salient one (Bardolet, Fox, & Lovallo, 2011). In the second-level negotiation, the two firms would again arrive at an equal split

given that both are essential, each obtaining one quarter. Thus, in this example, a hierarchical bargaining structure dramatically

favorsthesinglefirm.

Using cooperative game theory, we analyze how the bargaining structure of the value chain for a specific product affects

the distribution of value among the contributing firms. We generalize the Shapley value (Shapley, 1953) and the core (Gillies,

1953; Shapley, 1952) byintroducing the concepts of t hehierarchical Shapley value and the hierarchical core. Wethen use these

concepts to study the effects of bargaining structure on the value split. Our research thus also contributes to the literature on

value capture theory (see the review by Gans & Ryall, 2017).

Our main findings are the following. The hierarchical core places the same bounds on the amount of value that a cluster

can capture in a hierarchical bargaining structure as the core does in a linear bargaining structure. The hierarchical Shapley

value, in contrast, makes predictions that differ from those of the standard Shapley value. To state them, we introduce the

concepts of complementarity gains—the increment in value that players create by acting jointly over the sum of what they

create individually—and of supercomplementarity, which, intuitively, means t hat larger complementarity gains are realized

toward the final levels of the value chain. Withsupercomplement arity, a participant in the top-level negotiation benefits if other

participants are merged into clusters; in particular, a bargaining structure consisting of one firm and one cluster is advanta-

geous to the single firm compared with linear bargaining, a two-cluster hierarchical structure in a symmetric game is advan-

tageous to the smaller cluster, and a merger of two firms or clusters in the top-level negotiation is advantageous to the other

negotiators.

Given that the bargaining structure affects the distribution of value, each firm has an incentive to shape the value chain in

such a way as to maximize its own valuecapture—though few will be in a position to accomplish this. In a qualitative empirical

study of cases from the commercial aircraft and white goods (major appliance) industries, we show that bargaining structures are

indeed malleable and, to some extent, under the control of the central firm. We furthermore employ these examples to illustrate

the predictions derived from our model. Following Baldwin and Clark (2000), Colfer and Baldwin (2010), and Henderson and

Clark (1990), we suggest that firms can leverage a modular product architecture to shape industry architecture, the respective

value chain architecture, and, thus, the bargaining structure.