How value migrates within an industry architecture: Kingpins, bottlenecks, and evolutionary dynamics

This paper explores the dynamics of value distribution within a sector. It provides exploratory quantitative evidence on how conditions within the segments of a sector’s value chain affect the relative profitability of those segments. We consider how value shifts from one part of the value chain to another by linking two different but causally connected levels of analysis: the inequality of capability within a segment and the segment’s share of total sector profit. We show that the presence of superior firms (‘kingpins’) in a segment increases the segment’s share of total sector value, and establishes the segment as a bottleneck. Although kingpins exert a positive externality on their direct competitors, a ‘bottleneck’ segment displays more internal inequality, making the presence of ‘kingpins’ a double-edged sword. INTRODUCTION Understanding the foundations and evolution of profitability and value is at the core of strategy research. The existing literature, drawing on Industrial Organization (I/O) economics (Rumelt, 1991; Schmalensee, 1985) on the one hand, and on the Resource-Based View (RBV) (Barney, 1991; Teece et al., 1997; Wernerfelt, 1984) on the other, has identified several factors that drive profitability. Related research on patterns of profit accumulation (Dierickx & Cool, 1989; Pacheco de Almeida & Zemsky, 2007) or on the game-theoretic foundations of competitive advantage (Bradenburger & Stuart, 1996) has extended our understanding. But, while the questions of how profits emerge and why they are sustained are still debated (see Lipmann & Rumelt, 2003; Jacobides, Winter & Kassberger, 2011), our understanding of how profit and value change over time is even sketchier. In particular, the current literature leaves two issues underexplored: first, the systematic connection between different parts of a sector or value chain 1 ; and second, the dynamic aspects of profitability – particularly the factors that dictate how profit and value evolve by shifting from one part of the value chain to another. This paper primarily focuses on the first issue, and in so doing, extends the growing literature on dynamics of profitability. The evolution of the computer sector provides an excellent illustration of the way profit and value shift from firms specializing in one activity (computer assemblers) to those specializing in other activities (software developers and microprocessor manufacturers). Our focus is on how profit migrates not only from one firm to the next within a particular setting (i.e. among computer 1 Throughout this paper, we use the words ‘sectors’ and ‘industries’ interchangeably. The term ‘value chain’, (Porter, 1985) was originally used for linked activities or functions within a single firm, but has also come to refer to the different activities involved to produce a final good / service across firm boundaries. Different segments make up a vertically related value chain/ecosystem: Each of the various value-adding activities is referred to as ‘a segment’. 2 So far we have used the words ‘profit’ and ‘value’ synonymously, but they are not coterminous. We leave the manifold problems of the definition of ‘profit’ aside (see Lippman & Rumelt, 2003, for a discussion). Instead, we use an intuitive sense of profit and value based on market capitalization, which, for all its shortcomings, is a useful starting point. Market cap is the NPV of future profits (or cash flows), and corresponds to a sense of value that is appropriated by the firms’ owners, and as such is close to the normal sense of the word ‘profit’ (see Jacobides, Winter & Kassberger, 2011 for a detailed explanation).