The concept of value migration was introduced by Adrian Slywotzky. Value migration is the process of transitioning from outdated business models to more effective designs that are able to better satisfy customers’ most important priorities. Customer priorities and current business designs are disconnected, resulting in value migration. It explains the big successes/failures in various markets corresponding to underlying business trends. The priorities of customers are constantly changing. A business that recognizes this issue and takes action at the right time will be on the right side of the customer equation. The report will demonstrate to you how those who do not migrate value will be on the wrong side of the equation.
Value Migration Stages
Value migration consists of three stages:
- Value inflow: In this phase, company or an industry captures additional value from other industries or companies. Companies and industries gain market share and profit margins.This is an ideal phase for any company. Innovative companies with new technology and companies that have a unique value proposition are the habitats of the value inflow stage. Currently, the Indian jewelry industry is experiencing the value inflow phase, where value is moving from the unorganized sector to brands. The Indian pharmaceutical industry is also experiencing value inflow, with the Chronic segment gaining at the expense of Acute. Even the Telecom industry is seeing value inflow for its Data segment.
- Equilibrium: In this phase, companies and industries become stable. Rates of growth slow down.In addition, the market shares of incumbents settle down and a certain comfort zone is established. This typically sets the stage for the subsequent phase. This phase comprises a large number of business models – well-developed segments with limited penetration, oligopolies, and industries that are regulated. The Indian pharmaceutical and information technology industries are currently in an unstable phase. Value migration will be affected by the speed of innovation and new value propositions.
- Inversion of value: Value shifts away from companies to industries to meet changing customer needs. During this phase of growth, market share declines, margins contract, and growth stops. As a result, market shares decrease, margins contract, and growth ceases. Competition for customers is intense in this phase, marked by price wars and customer retention battles. In the value outflow stage, mature business models, saturated industries are typically experiencing stagnant innovation. From motorcycles to scooters, incremental value is migrating to the two-wheeler industry in India. As the Telecom industry matures, Voice segment value is outflowing and Data segment value is inflowing. Power segment value is outflowing from conventional to renewable energy sources.
Valuation migration types
There are several ways that value migration can manifest itself.
Four broad categories can be recognized:
Migration within the same industry
It is quite rare for value to migrate from one country to another, but wherever this happens, the potential for value creation is enormous. In India, there are a plethora of examples of the movement of value between companies – from public to private sector, and from the unorganized to the organized.
Migration between countries (international)
Only a few services are geographically independent in international value migration. Every industry cannot be migrated internationally. But international value migration occurs in several cases. The report examines two such cases (Indian IT and Indian Pharmaceuticals). In the end, what matters most is identifying the customer’s needs/priorities and creating a business model that addresses these needs/priorities to the maximum extent possible.
Migration between industries in the same country
Considering India’s advantage of a low-cost skilled workforce, the Indian IT industry has vastly benefited from global value migration. India’s IT industry has been growing steadily for the past 20-30 years, creating several local giants. This case examines how the industry has evolved.
Migration within the same company segment
A further fine example of international value migration induced by cost and niche capabilities is the Indian pharmaceutical industry. Low-cost labor did not play a major role in Indian IT as it does in other industries. Research and development spending and backward integration played a larger role.
Timeframe for Value Migration
There is a relationship between the length of the value migration stage and the amount of value created. The longer the value migration stage, the greater the value creation. The value migration process usually takes several years, if not decades, to complete.
There are three factors that affect the duration of value migration:
1. Value migration’s strength is another factor.
2. The incumbent’s ability to innovate and meet constantly changing consumer requirements and priorities.
3. Value migration is more likely to continue as long as the driver of the competitive advantage is strong. Low costs and a skilled workforce are factors that drive value migration in the IT sector, for instance. Over the past few decades, value migration has been maintained and its drivers are still evident.
We demonstrate in this report through a variety of examples how to value migration lasts for years/decades. The opportunity to gain outsized investment returns may still exist even if one discovers a case of value migration late in the process. While the value migration has already been underway for over a decade, it continues today in Indian banking and jewelry. It is inevitable that the earlier one can identify and capitalize on value migration, the greater is the prospect of outsized returns. There can be short-duration value migration in technology-oriented sectors, as rapid technological advancements result in constant value migration away from incumbents (unless the incumbents themselves drive the value migration). This report focuses on the case of value migration in the Jewelry industry, which has been underway for more than a decade, but is still underway, as organized players hold a low share. Other examples of this are the migration to generics in Pharma, the migration from public banks to private ones, and the migration in the cement sector.
Inverse Value Migration
The possibility of restoring “Value” After examining value migration as a framework for investments in the previous section and highlighting several drivers and examples, this section looks at the possibility of reverse value migration. A simple definition of reverse value migration is the flow of value back to the point of origin. The reverse value migration occurs when the value has moved from industry A to industry B. This presents challenges to incumbents as customer priorities continuously shift. Our belief is that incumbents shouldn’t lose out on value capture/migration because such shifts also provide significant opportunities for them. Incumbent companies can retain their market position by creating a responsive business design that accommodates changing priorities. In other words, value migration is the process of relocating underlying value from product/business design to cater to changing customer priorities, rather than its disappearance. Having been at the receiving end of value migration, reverse value migration demonstrates that it is possible to regain value. To succeed, this strategy requires a combination of factors, notably the ability to re-establish the relevance of the product segment back in the minds of customers after suffering during the first phase of value migration. We also believe you need to be innovative in order to bring the product back to the forefront and make sure you are happy with the end result.
One of the most noticeable examples of reverse value migration is the two-wheeler industry in India, where value shifted from scooters to motorcycles and now back to scooters. The transportation sector offers another example of reverse value migration, where the value first migrated from road to rail, after which it returned to the road. As a result, it is now moving back to rail as constraints are being addressed.
How is value migration caused?
Value migration is dependent on customer priorities, which vary for a variety of reasons. Value migration could therefore be driven by a variety of factors. Technological advancements, cost savings, convenience, lowering of entry barriers, lower switching costs, easy access to capital, and innovation are time-tested drivers. In India, value migration from the public to private sectors occurs as a result of improving technology, greater convenience, and lower costs (better value for money propositions). Due to a combination of these factors, public sector enterprises have lost market share. Private participants have become increasingly capable of investing and expanding the franchise as they gained share and scale.
What are the methods for detecting value migration?
Value migration trends can be identified early, helping to maximize investment gains. In this case, naturally, the critical question is how to spot value migration in its earliest stages? Value migration is difficult to detect, even for a company/management that is totally involved in running it’s business and implementing strategies. During the value inflow phase, most of the organization’s energy and resources will be used to meet consumer demand. It’s easy to become complacent during the stability phase and fail to detect migration early. Finally, in the phase of value outflow, the focus is on preventing losses. It can be difficult to understand the initial stages of value migration because they are quite gradual and subtle.
Value migration is also difficult to detect when it is driven by new competition (and not the incumbents). Since Royal Enfield was not a traditional competitor in the Two Wheeler Industry, Eicher’s Royal Enfield did not cause concern at the outset. In the quarters/years after Eicher Motors gained market share, the impact became evident. It is nevertheless possible to gain an edge by detecting migration early and becoming aware of potential winners and avoiding players who are on the wrong side.
The following are some factors that can assist investors in detecting value migration earlier, in our opinion:
A] Market share movements provide a very strong signal of value migration. A pattern of consistent share gains is often a harbinger of bigger trends. For instance, IDG’s consistent expansion in the airline market, Private Bank’s share gain in savings deposits, and Eicher’s strong performance in premium two-wheeler spaces all suggest a distinct value migration shift across the underlying business.
B] An additional metric to find potential beneficiaries of value migration is innovation leadership. Those who innovate and create new categories/subcategories are rewarded with first-mover advantages and trigger value migration. It has a 55-56% market share in decorative paints, establishing itself as a market leader. Yet it’s been innovation leadership that has cemented the company’s position as an industry leader and allowed it to maintain market shares over the years (gained 1,500bps in 15 years). In addition to tinting machines and home solutions, ColorWise has introduced several new concepts to the industry. About a decade ago, Shree Cements switched to petcoke as its preferred fuel, a trend that the rest of the industry has not adopted until the last couple of years.
As a result, Shree cement is increasingly switching to waste heat recovery in order to reduce the cost of its power.
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