Value chain analysis

Definition

 Is a process where a firm identifies its primary and support activities that add value to its
final product and then analyze these activities to reduce costs or increase differentiation.
 is a strategy tool used to analyze internal firm activities
 Introduced by the Michael E. Porter in 1985

Function

 To recognize, which activities are the most valuable (i.e. are the source of cost or
differentiation advantage) to the firm and which ones could be improved to provide
competitive advantage.
 Reveals where a firm’s competitive advantages or disadvantages are.
 helps a company understands how it adds value to something and subsequently how it
can sell its product or service for more than the cost of adding the value, thereby
generating a profit margin
 Describes the activities that take place in a business and relates them to an analysis of
the competitive strength of the business.

Porter’s Value Chain Model

Primary activities

1. Inbound logistics
a. Processes that are involved in the receiving, storing, and internal distribution of
the raw materials or basic ingredients of a product or service. The relationship
with the suppliers is essential to the creation of value in this matter.
2. Production
a. Activities (for example production floor or production line) that convert inputs of
products or services into semi-finished or finished products. Operational systems
are the guiding principle for the creation of value.
3. Outbound logistics
a. Activities that are related to delivering the products and services to the customer.
This includes storage, distribution (systems) and transport.
4. Marketing & sale
a. Processes related to putting the products and services in the markets including
managing and generating customer relationships.
5. Service
a. Activities that maintain the value of the products or service to customers as soon
as a relationship has developed based on the procurement of services and
products.

Supporting activities

1. Firm infrastructure
a. Concerns the support activities within the organization that enable the
organization to maintain its daily operations. Line management, administrative
handling, financial management are examples of activities that create value for
the organization.

2. Human resource management

a. Includes the support activities in which the development of the workforce within
an organization is the key element. Examples of activities are recruiting staff,
training and coaching of staff and compensating and retaining staff.
3. Technology development
a. This activities relate to the development of the products and services of the
organization, both internally and externally. Examples are IT, technological
innovations and improvements and the development of new products based on
new technologies. This activity creates value using innovation and optimization.
4. Procurement
a. Support activities related to procurement to service the customer from the
organization. Examples of activities are entering into and managing relationships
with suppliers, negotiating to arrive at the best prices, making product purchase
agreements with suppliers and outsourcing agreements. Organizations use
 primary and support activities as building blocks to create valuable products,
services and distinctiveness.

COMPETITIVE ADVANTAGES

There are two different approaches on how to perform the analysis, which depend on what type
of competitive advantage a company wants to create (cost or differentiation advantage):

A) COST ADVANTAGE

This approach is used when organizations try to compete on costs and want to
understand the sources of their cost advantage or disadvantage and what factors drive
those costs.

To gain cost advantage a firm has to go through 5 analysis steps:

Step 1. Identify the firm’s primary and support activities. All the activities (from
receiving and storing materials to marketing, selling and after sales support) that are
undertaken to produce goods or services have to be clearly identified and separated
from each other. This requires an adequate knowledge of company’s operations
because value chain activities are not organized in the same way as the company itself.
The managers who identify value chain activities have to look into how work is done to
deliver customer value.

Step 2. Establish the relative importance of each activity in the total cost of the
product. The total costs of producing a product or service must be broken down and
assigned to each activity. Activity based costing is used to calculate costs for each
process. Activities that are the major sources of cost or done inefficiently (when
benchmarked against competitors) must be addressed first.

Step 3. Identify cost drivers for each activity. Only by understanding what factors
drive the costs, managers can focus on improving them. Costs for labor-intensive
activities will be driven by work hours, work speed, wage rate, etc. Different activities will
have different cost drivers.

Step 4. Identify links between activities. Reduction of costs in one activity may lead to
further cost reductions in subsequent activities. For example, fewer components in the
product design may lead to less faulty parts and lower service costs. Therefore
identifying the links between activities will lead to better understanding how cost
improvements would affect he whole value chain. Sometimes, cost reductions in one
activity lead to higher costs for other activities.

Step 5. Identify opportunities for reducing costs. When the company knows its
inefficient activities and cost drivers, it can plan on how to improve them. Too high wage
rates can be dealt with by increasing production speed, outsourcing jobs to low wage
countries or installing more automated processes.
 B) DIFFERENTIATION ADVANTAGE

The firms that strive to create superior products or services use differentiation advantage
approach.

Step 1. Identify the customers’ value-creating activities. After identifying all value
chain activities, managers have to focus on those activities that contribute the most to
creating customer value. For example, Apple products’ success mainly comes not from
great product features (other companies have high-quality offerings too) but from
successful marketing activities.

Step 2. Evaluate the differentiation strategies for improving customer value.

Managers can use the following strategies to increase product differentiation and
customer value:

 Add more product features;

 Focus on customer service and responsiveness;
 Increase customization;
 Offer complementary products.

Step 3. Identify the best sustainable differentiation. Usually, superior differentiation

and customer value will be the result of many interrelated activities and strategies used.
The best combination of them should be used to pursue sustainable differentiation
advantage.

The three steps for conducting a value chain analysis are:

1. Separate the organisation’s operations into primary and support activities
a. Primary activities are those that physically create a product, as well as market
the product, deliver the product to the customer and provide after-sales support.
Support activities are those that facilitate the primary activities, for example, HR.
2. Allocate cost to each activity
a. Activity cost information provides managers with valuable insight into the internal
capabilities of an organisation.

3. Identify the activities critical to customer satisfaction and market success

a. There are three important considerations in evaluating the role of each activity in
the value chain:
i. Company mission - influencing the choice of activities undertaken.
 ii. Industry type - which influences the relative importance of activities. The
value chain for a service industry, for example, will look very different
from that of a manufacturing industry
iii. Value system, including the value chains of an organisation’s upstream
and downstream partners in providing products to end-customers.

The Advantages of Value Chain Analysis

1. A big advantage is that the value chain is a very flexible strategy tool for looking at your
business, your competitors and the respective places in the industry’s value system.
.
2. The value chain can be used to diagnose and create competitive advantages on both
cost and differentiation.

3. It helps you to understand the organisation issues involved with the promise of making
customer value commitments and promises because it focuses attention on the activities
needed to deliver the value proposition.
.
4. Comparing your business model with your competitors using the value chain can give
you a much deeper understanding of your strengths and weaknesses to be included in
your SWOT analysis.
.
5. The value chain is well known and has been a mainstay of strategy teaching in business
schools for the last 20 to 25 years
.
6. It can be adapted for any type of business – manufacturing, retail or service, big or
small.
.
7. The value chain has developed into an extra model, the industry value chain or value
system which lets you get a better understanding of the much broader competitive
arena.

The Disadvantages Of Value Chain Analysis

1. It’s very strengths of flexibility mean that it has to be adapted to a particular business
situation and that can be a disadvantage since, to get the best from the value chain, it’s
not “plug and play”.
2. The format of the value chain laid out in Porter’s book Competitive Advantage, is
heavily oriented to a manufacturing business and the language can be off-putting for
other types of business.
3. The scale and scope of a value chain analysis can be intimidating. It can take a
lot of work to finish a full value chain analysis for your company and for your main
competitors so that you can identify and understand the key differences and strategy
drivers.
 4. Many people are familiar with the value chain but few are experts in its use.

5. The value chain idea has been adopted by supply chain and operations experts and
therefore its strategic impact for understanding, analysing and creating competitive
advantage has been reduced.

6. Business information systems are often not structured in a way to make it easy to get
information for value chain analysis.

CONCLUSION

 Identify the company’s strengths & weaknesses

 Make comparison with competitors
 Increase customer satisfaction
 Better efficient flow of stocks