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Lead Your Team Strategy

What is a Value Chain Analysis?

Value chain chart
The value chain includes a business' primary activities. These activities should be run at optimum level if the organization is to gain any real competitive advantage. / Credit: Kheng Guan Toh | Shutterstock

If you are searching for a way to gain an edge on your competition, consider one of the business world's most valuable tools: the value chain analysis. 

Value chain analysis relies on the basic economic principle of advantage — companies are best served by operating in sectors where they have a relative productive advantage compared to their competitors. Simultaneously, companies should ask themselves where they can deliver the best value to their customers. 

To conduct a value chain analysis, the company begins by identifying each part of its production process and identifying where steps can be eliminated or improvements can be made. These improvements can result in either cost savings or improved productive capacity. The end result is that customers derive the most benefit from the product for the cheapest cost, which improves the company's bottom line in the long run.

What is a value chain?

To understand how to conduct a value chain analysis, a business must first know what its value chain is. A value chain is the full range of activities — including design, production, marketing and distribution — businesses go through to bring a product or service from conception to delivery. For companies that produce goods, the value chain starts with the raw materials used to make their products, and consists of everything that is added to it before it is sold to consumers.

The process of actually organizing all of these activities so they can be properly analyzed is called value chain management. The goal of value chain management is to ensure that those in charge of each stage of the value chain are communicating with one another, to help make sure the product is getting in the hands of customers as seamlessly and as quickly as possible.

Porter's value chain

Harvard Business School's Michael E. Porter was the first to introduce the concept of a value chain. Porter, who also developed the Five Forces Model that many businesses and companies use to figure out how well they can compete in the current marketplace, first discussed the value chain concept in his book "Competitive Advantage: Creating and Sustaining Superior Performance" (Free Press, 1985).

"Competitive advantage cannot be understood by looking at a firm as a whole," Porter wrote. "It stems from the many discrete activities a firm performs in designing, producing, marketing, delivering and supporting its product. Each of these activities can contribute to a firm's relative cost position and create a basis for differentiation"

According to LearnMarketing, Porter suggests that activities within an organization add value to the service and products that the company produces, and that all of these activities should be run at optimum level if the organization is to gain any real competitive advantage. If they are run efficiently, the value obtained should exceed the costs of running them — for example, customers should return to the company and transact freely and willingly.

In his book, Porter said a business's activities could be split into two categories: primary activities and support activities. Primary activities include the following:

  • Inbound logistics: This refers to everything involved in receiving, storing and distributing the raw materials used in the production process.
  • Operations: This is the stage where raw products are turned into the final product.
  • Outbound logistics: This is the distribution of the final product to consumers.
  • Marketing and sales: This stage involves activities like advertising, promotions, sales-force organization, selecting distribution channels, pricing, and managing customer relationships of the final product to ensure it is targeted to the correct consumer groups.
  • Service: This refers to the activities that are needed to maintain the product's performance after it has been produced. This stage includes things like installation, training, maintenance, repair, warranty and after-sales services.

The support activities help the primary functions and comprise the following:

  • Procurement: This is how the raw materials for the product are obtained.
  • Technology development: Technology can be used across the board in the development of a product, including in the research and development stage, in how new products are developed and designed, and process automation.
  • Human resource management: These are the activities involved in hiring and retaining the proper employees to help design, build and market the product.
  • Firm infrastructure: This refers to an organization's structure and its management, planning, accounting, finance and quality-control mechanisms.

Goals and outcomes

Ideally, your value chain analysis will help your company identify areas that can be optimized for maximum efficiency and profitability. 

Ruth Campbell, senior vice president of technical learning and application at economic development nonprofit ACDI/VOCA told Business News Daily that the best result of a value chain analysis should be the identification of the following components:

  • Key short- and medium-term end-market opportunities in the target value chains.
  • Factors constraining the maximization of these opportunities (for small-scale producers, women, youth, etc.).
  • Upgrading strategies to address these constraints and maximize opportunities.
  • Private-sector, public-sector and civil society entities to partner with to achieve these upgrading strategies.
  • Recommendations of how to support these value chain upgrading strategies in a way that is gender equitable, promotes improved nutrition (where relevant), and is inclusive of the poor and other marginalized group.

At the other end of the spectrum, it's critical to properly understand and implement suggestions that arise as a result of a value chain analysis. 

"One common misconception is that every constraint identified in a value chain analysis must be addressed," Campbell said. "Value chain analysis should be used to prioritize the most binding constraints — the ones that, if addressed, will produce the most beneficial impact — and/or those constraints that can be addressed relatively quickly and easily to produce momentum for change among value chain actors."

Campbell also cautioned that if an analyst constructs your value chain analysis, it is up to you as the business owner or manager to make the most of his or her suggestions. 

"Social norms exert a huge influence in many contexts over what strategies are considered possible or acceptable," Campbell said. "A vision for VC development cannot be imposed by the analyst onto the local actors. Market actors have to embrace the vision if they are to invest their resources and change the way they do business."

While value chain analysis is a tested and proven tool, other standards for analysis aim to embrace a business model that is not strictly business-to-consumer. Specifically, the Leveraging Economic Opportunities (LEO) Market Systems Framework aims to help companies that rapidly respond to changing market conditions and interface more broadly with household and communities than the traditional business assumed by value chain analysis. More information on this strategic analysis tool is available from USAID.

Value chain templates

There are many free templates online to help businesses determine and analyze their value chains. Some of the templates can be found at the following sites:

Additional reporting by Chad Brooks, Business News Daily senior writer.

Originally published on Dec. 20, 2013. Updated Jan. 26, 2015.