With ever-increasing competition for unbeatable prices, exceptional products and customer loyalty, businesses must continually evaluate the value they create. One of the most valuable tools, the value chain analysis, provides businesses an advantage over their competition.
Chartered Global Management Accountant (CGMA) discusses the benefits of a value chain analysis: "Value chain analysis can help organisations to gain better understanding of key capabilities and identify areas for improvement. It can help them to understand how competitors create value; and help organisations to decide whether to extend or outsource particular activities."
A business begins by identifying each part of its production process, noting steps that can be eliminated and other possible improvements. In doing so, businesses can determine where the best value lies with customers, and expand or improve said value, resulting in either cost savings or enhanced production. At the end of the process, customers can enjoy high-quality products at lower costs.
What is a value chain?
A value chain is the full range of activities – including design, production, marketing and distribution – businesses conduct 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 added before the product is sold to consumers.
Value chain management is the process of organizing these activities in order to properly analyze them. The goal is to establish communication between the leaders of each stage to ensure the product is placed in the customers' hands as seamlessly 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 to show businesses where they rank in competition in the current marketplace, discussed the value chain concept in his book "Competitive Advantage: Creating and Sustaining Superior Performance" (Free Press, 1998).
"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."
In his book, Porter splits a business's activities into two categories: primary and support.
Primary activities include the following:
- Inbound logistics are the receiving, storing and distributing of raw materials used in the production process.
- Operations is the stage at which the raw materials are turned into the final product.
- Outbound logistics are the distribution of the final product to consumers.
- Marketing and sales involve advertising, promotions, sales-force organization, distribution channels, pricing and managing the final product to ensure it is targeted to the appropriate consumer groups.
- Service refers to the activities needed to maintain the product's performance after it has been produced, including installation, training, maintenance, repair, warranty and after-sale services.
The support activities help the primary functions and comprise the following:
- Procurement is how the raw materials for the product are obtained.
- Technology development can be used in the research and development stage, in how new products are developed and designed, and in process automation.
- Human resource management includes the activities involved in hiring and retaining the proper employees to help design, build and market the product.
- Firm infrastructure refers to an organization's structure and its management, planning, accounting, finance and quality-control mechanisms.
Conducting the analysis
According to Strategic Management Insight, there are two approaches to the value chain analysis: cost and differentiation advantage.
Cost advantage: After identifying the primary and support activities, businesses should identify the cost drivers for each activity. For a more labor-intensive activity, cost drivers could include how fast work is completed, work hours, wage rates, etc. Businesses should then identify links between activities, knowing that if costs are reduced in one area, they can be reduced in another. Businesses can then identify opportunities to reduce costs.
Differentiation advantage: Identifying the activities that create the most value to customers is the priority. These can include using relative marketing strategies, knowing about products and systems, answering phones faster, and meeting customer expectations. The next step is evaluating these strategies to improve the value. Focusing on customer service, increasing options to customize products or services, offering incentives, and adding product features are some of the ways to improve activity value. Lastly, businesses should identify differentiation that can be maintained and adds the most value.
Free templates are available online to help businesses determine and analyze their value chains.
Goals and outcomes
According to Investopedia, the primary goal of using the value chain analysis is creating or strengthening your business's competitive advantage.
"If a company can create an advantage ... through a value chain analysis, it captures a competitive advantage and increases its overall profit," the article explains. "To capture a competitive advantage, a company maps out its specific activities within the five generic value chain activities and looks for ways to create efficiencies."
Ideally, value chain analysis will help you identify areas that can be optimized for maximum efficiency and profitability. It is important, along with the mechanics of it all, to keep customers feeling confident and secure enough to remain loyal to your business. By analyzing and evaluating product quality and effectiveness of services, along with cost, your business can find and implement strategies to improve.
Additional reporting by Katherine Arline.