In previous post, we looked at the difference between integrated and modular players and why integrated players are well positioned to enter new product categories. Now let us look at the dynamics of value accumulation in modular value chains.
Taking mobile phone industry as an example, there are various companies that are built around manufacturing Screens, Batteries, Networking, Speakers, Camera Lens, etc. We expect the profit accumulation to happen at the point of integration. I.e., logically, manufacturers like Samsung, One Plus, Xiaomi, etc who integrate these modular parts into completed products are rational candidates for value accumulation. But.. manufacturers like Qualcomm and Google who build processors and operating system respectively, by virtue of their irreplaceable nature accumulate all the profits in the value chain.
If you look at it, components like Battery, RAM, Display, etc are replaceable; Mobile phone manufacturers like One Plus, Xiaomi are replaceable too (Not truly, but one manufacturer going out of business would not be end of this world) but Qualcomm and Android aren't replaceable because of how well they integrate with each other. Once network effects kick in (a new processor entails rewriting of OS and Applications, A new OS requires developers to learn a new SDK all over) replacing these players becomes nearly impossible.
In Summary, even within Modular Value Chains, players that integrate most of the functions (an OS supports multiple screen resolutions, multiple audio and video codecs, A processor supports the most common OS very well, etc ..) accumulate most value.
Why is Understanding This Important?
Let's turn this 180 degrees and see, how to identify when a value chain is turning modular and spot where the consolidation of irreplaceablity is happening.
In Retail value chain, Retailers, who used to control demand (as they were the portals through which consumers got what they needed) acted as integrated players. They integrated the logistics and convenience with their huge footprint making it easier for consumers to purchase products. And hence, accumulated the most value.
When Internet became available for everyone and e-commerce took off, it decreased importance of retailers in the value chain. Manufacturers started passing the mark up which was earlier earmarked for retailers as discounts to consumers and it proved to be a win-win for everyone. Until now.
Enter Facebook, Google
Like retailers acted as gatekeepers of demand in offline retail, Facebook and Google have now taken that role in online retail. Producers of products who used to pay a mark up for retailers are now paying Facebook and Google for Ads. Facebook and Google now have so much power over consumer demand that the internet companies are now contemplating to go the retail route!
Like Retailers integrated logistics and physical store fronts which enabled them to control demand, Facebook and Google have built massive user base, to an extent where internet companies are compelled to invest in these two platforms for ads to gain visibility.
Takeaways
Even in Modular Value chains, the places where the most integration happens accumulates all the value in the whole chain (reasons might be irreplaceability or network effects)
When technologies like Internet rewrites the value chains, the integrated players are only replaced but not gotten rid off
*The Value chains represented are simplified for the context. They are lot more complex and have many players.