Value Chain Analysis

A company’s value chain identifies the primary activities that create value for customers and related support activities. Value chain analysis identifies the separate activities and business processes that are performed from the designing of a product to supporting it.

Value chain analysis is viewed as a means of evaluating a firm’s strengths and weaknesses. It assumes that a firm’s basic economic purpose is to create value.

The strategy-making lesson of value chain analysis is that increased company competitiveness hinges on managerial efforts to concentrate company resources and talent on those skills and activities where the company can gain dominating expertise to serve its target customers.

Value chain analysis is a powerful managerial tool for identifying which activities in the chain have competitive advantage potential. The value chain identifies the activities and business processes that have to be performed in designing, producing, marketing, delivering, and supporting a product or service.

It identifies the primary activities that create value for customers and related support activities. Value chains are a tool for thinking strategically about the relationships among activities performed inside and outside the firm.

The chain of value-creating activities starts with raw materials supply and continues through manufacturing, assembly, wholesale distribution, and retailing to the ultimate end users of the product or service.

A company’s value chain shows the linked set of activities and functions it performs internally.

The chain includes a profit margin because a markup over the cost of performing (the firm’s) value-creating activities is customarily part of the price borne by buyers.

The value chain of a manufacturing company is presented below which depicts a value chain for a watch manufacturing company.

value chain of a manufacturing company

Primary Activities of Value Chain Analysis

The most important application of Value Chain Analysis is to expose how a particular company’s cost position compares with the cost positions of its rivals.

What is needed are competitor-versus-competitor estimates for supplying a product or service to a well-defined customer group or market segment.

A company’s cost competitiveness depends not only on the costs of internally performed activities (own value chain) but also on cost in the value chains of its suppliers and forward channel allies.

A company’s relative cost position and overall competitiveness are linked with the entire industry value chain system.

The value chain is based on the premise that the creation of customer value is the route to sustained competitive advantage. The value is created by the interplay of activities and not functional profiles and lies in either the ability to be a low-cost producer or a differentiator.

There is a set of activities that are core to the value chain and a set of activities that are supportive of the core ones.

The generic primary or core activities according to Michael Porter (1985) are – inbound logistics, outbound logistics, operations, and marketing and sales and service. Table 3.2 shows the primary activities, the key tasks and the implication of those for strategy.

Primary ActivitiesKey Tasks

Implications for

Strategy

Inbound Logistics

Vendor relationships inventory management.

Warehousing.

Procure, sort, label, transport assemble, load on production etc.Differentiation advantage of superior input at low cost or its scarcity appeal. Quality inputs and quality output.

Operations

Productivity automation of production, plant layout workflow design material handling.

Manufacturing, machining, tooling assembling, testing, etc.

Quality based differentiation.

Cost advantage with automation, or synergy among different businesses for production, or common use of facilities.

Outbound Logistics

Supply to the customer through intermediaries finished goods dispatch warehousing.

Management of intermediaries, managing efficiency in supply to customers, timeliness of supplies.

Reduce intermediaries for cost advantage.

Superior value creation by intermediaries such as cold chains.

Marketing and Sales

Marketing research promotion, advertising, branding, channel management innovation in selling.

Managing the product life cycle, price point determination, managing the sales force, administering the marketing mix.Differentiate based on quality, exclusivity. Gain market share by aggressive promotion for cost advantage.

Service

Replacement, guarantee warranty attention to customer complaints.

 

Develop the sales force, build customer relationship policies, train for performance seek continuous improvement.

Differentiation advantage.

Unique service management with differentiated inimitable skillset.

The support activities create the ground for primary activities. These include firm infrastructure, human resource management, and technology development and procurement.

For each of the support activity the key factors are;

  • Firm Infrastructure
    • Information system support.
    • Coordination and support of value chain activities.
    • Planning and control. Ability to access resources at lower rates including the capital.
    • Quality of the strategic planning system.
    • Public image and corporate citizenship.
    • Ability to spot opportunities and threats.
  • Human Resource Management
    • The efficiency of procedures for recruitment selection and training.
    • Reward and recognition systems.
    • Extent and level of employee motivation.
    • The nature of the work environment to reduce absenteeism and turnover.
  • Technology Development
    • The extent of the development of research and development.
    • Quality of research facilities.
    • Seamlessness between technology development and transfer.
    • Type of working relationship between the technology development department.
    • Rate of success of the technology development initiatives leading to product or process innovations or improvements.
  • Procurement
    • Capacity to minimize the dependence on dominant suppliers.
    • Relationship with the different vendors to procure in emergent circumstances, to negotiate lowest prices, to enter into long term contracts at low rates, to enforce quality standards in supplies.
    • Appropriateness of procedures to order capital intensive items.
    • Development of criteria for lease/hire of property/equipment.
    • Goodwill and amicable relationship with lead suppliers.

Porter (1985) developed and studied the value chain as the basis of creating either cost-based or differentiation advantages. Customer value is created by lower prices, superior product performance or outstanding customer service.

The purpose of the value chain analysis is to identify those key activities that improve the efficiency and the efficacy of the generic production system by either lowering the cost or adding value to those activities.

Every business that interfaces with many other businesses to buy, sell, transport, insure, deliver, store or support has its value chain.

Understanding the value chain of that key business which contributes to our competitive advantage can help in aligning the activities better and attaining greater immunity from copying.

Understanding generic value chain

To understand this let us take the example of a manufacturer whose products have a low-cost advantage.

What is important for the manufacturer is that the low-cost advantage is not restricted to any one core activity such as a low-cost supplier. That advantage is imitable and the competitive position will be weakened sooner than later.

The low cost must also derive from a combination of operations and outbound logistics, inbound logistics in a manner that is specifically unique and cannot be copied easily.

Such a configuration would imply that the organization captures the cost of the value of cost advantage rather than the supplier or intermediaries.

In case the organization’s internal process activities do not support its main competitive thrust then the competitive position is also weakened. Consider the case of a retail chain that claims a customer­centric replacement policy. It is worthwhile for the organization to examine if the activities necessary to create the hassle-free replacement experience are in place.

  • Can the customer get a replacement from any counter at any time?
  • Has the organization done a dummy drill on how much time and movement it takes to get a replacement?
  • Are the activities centered on the ease of the customer or the financial audit needs of the organization?
  • Apple Computers and Marks and Spencer have customer­centric replacement activities.

The below figure shows the overlap of two value chains to deliver customer experience.

Value Chain for Customer Friendly Replacement

The bold line portion of the figure represents the superior experience created by three intervening variables. Such an advantage is inimitable.

Disaggregation of Internal Context Factors: Comparison of Porter’s Value Chain, Balanced Scorecard and McKinsey 7S Framework

Porter’s Value Chain, Balanced Scorecard and McKinsey 7S Framework provide an indicative approach for those factors that the organization may consider. The table below enlists the salient features of each for a quick review.

Porter’s Value ChainBalanced ScorecardMcKinsey 7S Framework
Linked to competitive strategy.Linked to the grand strategy.Focused on effectiveness.
Focus on activities that lead to cost or differentiation advantage.Focus on developing measures for the four factors that enable strategy execution.Focus on the overall effectiveness. Different advantages are rooted in the seven factors of the framework.
Use of qualitative and quantitative measures is possible.Measurement is the key and all the four factors are defined in a manner that quantitative and qualitative measurement is possible.Quantification is possible after the broad factors have been sub­classified.
Academic in orientation.Is practice-oriented.Broad-based developed from practice.
Inside out perspective.Inside out perspective.Outside in perspective.
Focus on hard aspects more than on the people aspects.Focus on the hard and the soft aspects in the form of learning and sharing.Equal focus on the hard and the soft aspect as well as on their complementarities.