Value Chain Analysis
Developed by Joseph Kurian
The term Value Chain is one of Michael Porter most famous concept along the five forces. It was introduced in his book "Competitive Advantage: Creating and Sustaining superior Performance" (1985). An analysis of the value chain both describes the activities of an organization and links them to the competitive position of the organization. This analysis results in identifying the activities that are a source of cost or lead to a differentiation advantage and those that could improve the competitive advantage of the company or of the project. This tool helps companies designing viable products or services at the right price.
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The Concept
Value chain analysis describes the activities in and around an organization and links them to an analysis of competitive strength of the organization. The analysis assesses which value every specific activity adds to the organisations products or services. This thought was based upon the knowledge that an organisation is more than an arbitrary gathering of machine, equipment, people and money. In order to produce something the customers are willing to pay for, these things have to be arranged into systems and systematic activities. According to Michael Porter, the ability of an organization to perform certain activities and to manage the linkages between those activities is through which competitive advantage can be gained.[1]
Porter differentiates between two sets of activities. All activities that are directly related to the creation or delivery of a product or service are called primary activities and support activities are those activities that are linked to each primary activity that tries to improves its efficiency and effectiveness.[1]
Primary Activities
- Inbound Logistics: all activities associated with the receiving, distributing and storing of incoming materials
- Operations: converting inputs (raw materials, energy and labor) into outputs (the final product/service)
- Outbound Logistics: all activities associated with the storage and movement of the final product to the end user
- Marketing and Sales: all activities involved in the assessment and encouragement of customers to purchase and the activities associated in providing a medium to purchase the product
- Service: activities related to the maintenance and enhancement of value to the end user after the product is sold
Secondary Activities
- Procurement: the acquisition of goods or services from an external source
- Human Resource Management: all activities associated with the management of people as per the requirements
- Technology Development: all activities related to the equipment, hardware, software, technical knowledge and procedures to transform the inputs into outputs
- Infrastructure: all other activities including legal, finance, accounting, public relations and quality assurance
Margin
The term Margin refers to the profit margin the company makes out of the activities of its value chain.[1] The margin is correlated with the company’s ability to articulate properly all the activities of the value chain. A high margin means the company is able to sell a product or a service for a much higher price than the cost of all the activities of the value chain. The linkages are flows of information, goods, services, and systems or processes adjusting activities.[1] Here are some examples to get a better idea of their importance. If the marketing & sales activities provide sales forecasts for the next period to all other departments reliable and on time, procurement will be able to order the right material for the correct date. Following this reasoning, if procurement forwards the orders to inbound logistics, then operations will be able to schedule production in order to forwarded it to the outbound logistics and guarantee the delivery of the products on time, meaning as expected by marketing & sales. This is why linkages are extremely important and represent the cooperation and information flow between the value chain activities needed to run the activities.
Organisations Value Chain
In most industries, the activities of the value chain, from product design, production of components, and final assembly to delivery to the final user, are not all handled by the company. Organisations are, as a result, part of a value system or supply chain. When analyzing the value chain, it is important to consider the one of the whole value system the chain is embedded in.[2] Within the whole value system, only a certain part of profit margin is available to the company. As stated previously, the profit margin is the difference of the final price the customer pays and the sum of all costs incurred with the production and delivery of the product/service. It depends on how the value system is structured, how this margin spreads across the suppliers, producers, distributors, customers, and other elements of the value system. Each organization in the system will negotiate and use its market position to get a higher share of the margin. However, collaborations and cooperation can be encouraged if there is the opportunity for both companies to improve their efficiency and reduce their costs. The result is to achieve a higher total margin that benefits of all of them. An example is reducing stocks in a Just-In-Time system.[2]
Industry Application
A firm needs to identify and deliberate its value proposition or its differentiation factor while taking its value chain into account. As the value chain analysis aims to improve the profits by creating superior products or services such that the customers are willing to pay a higher price than what it takes to make it, the company’s goal should be to improve its value chain in accordance to its competitive advantage rather than just improving the value chain for the sake of improvement.[3]
Two common strategies for attaining a competitive advantage are low cost provider or specialization /differentiation of products or service. [1] [3] In a low cost provider, the value chain analysis will focus on costs and how to reduce them, while in a specialization strategy; the value chin analysis will focus on uniqueness of the product or service.
Evidence of Improved Financial Performance
In 2004, Deloitte conducted a research into international value chains and found evidence of improved financial performance of companies adopting value chain principles. The analysis was based upon 300 survey respondents, each with annual revenues of at least US$200 million. [4]
The survey recognized that companies that could be categorized as ‘value chain complexity masters’ were on an average 73% more profitable than the other companies surveyed.[4] The identification of value chain complexity masters were based on their value chain capabilities such as product innovation, sourcing effectiveness, flexibility, productivity, product quality, cost effectiveness, time to market, supply chain costs structures, and customer service, and the value chain complexity factors such as the global dispersion of the entire supply chain from sourcing to sales. Companies with high complexity and high capability were classified as a complexity master.[4]
The results from the survey shows that the complexity masters, in comparison to the other organisations had higher competences in:[4]
- Customer related operations - broad interest in client coordinated effort ventures and client relationship management.
- Product related operation - enhancements in R&D through better process incorporation and interests in product information management systems and product lifecycle management systems.
- Supply chain operations - described by execution change activities such as quality management, fast changeover, lean manufacturing, and technologies such as warehouse management, planning and scheduling softwares and transportation systems.
Even though the research is not published in the peer reviewed academic literature, it validates that the value chain analysis is critical in achieving competitive advantage. It exhibits that best practice leads to superior financial performance.
Value Chain Analysis as a Project Management Tool
Using value chain analysis as a project management tool will help the project team to identify methods through which value can be added for both internal and external customers. It will further help to maximize this value created.
The tool can be used in a three-step process:
Analysis stage
Identification of activities to undertake in order to deliver the product or service.
The Activity Analysis stage requires the project team to brainstorm the activities necessary to undertake the project in order to add value, which eventually contributes to the end-user's experience. Therefore, this step requires an organized business process, which includes marketing, sales, order taking, operational process, delivery and support etc. that would help serve the customer needs.[5] In other words, this stage requires the project team to carry out a systematic flow of work. Furthermore, it would also involve other factors such as:
- How does the project motivate the team to perform more effectively?
- Recruitment methods? Recruitment of effective individuals with the right skill would give best value.
- How to select and develop technologies and techniques?
- How to keep up-to-date with effective technologies and techniques?
- How to get feedback from customers on performance?
The activities are then listed in a simple flow chart, giving a good visual representation of the value chain.
Value Analysis stage
Maximizing the value of each activity in developing the product or service.
The Value Analysis stage involves the project team to list value factors for each of the activity identified in the first stage. Value factors are those that the customers would value when an activity is conducted and they vary with the nature of business. In order to maximize the value for each activity, the requirements of what has to be done or changed is put down besides each value factors.[5]
Evaluating Changes and Planning of Action stage
Evaluation of changes and deciding whether the changes are worth making. The action plan is then followed to complete the project.[5]
The final stage involves the project team evaluating the changes and plans for action. The team has to prioritize from the list of generated ideas that adds value to the customer and pick the quick and simple tasks to increase the team spirit, subsequently adhering to the remaining changes. The more difficult tasks are tackled in a systemic manner, providing a steady improvement.[5]
Limitations
Although both academics and industries have generally accepted Porter’s model of competitive analysis as a conceptual strategy model, it has been commonly described as deficient for use in todays environment [6] [7] A few concerns in the general approach of the value chain model also include:
- Difficulty in managing the exchange of sensitive information.
- A decrease in cost and increase in benefits of one firm may yield to a negative impact on one of the partner firms.
- The fear of information abuse is high and it could lead to drastic problems
- Creating visibility along the whole supply chain in itself is a challenge and it stalls the progress of any analysis undertaken.
Similar to that of most academic frameworks, the limitations of value chain analysis can also be summarized into the following points.
- The increasing level of complexities in business operations, in real life, makes it difficult to clearly differentiate between primary and secondary activities
- The analysis requires a complete analysis of all business operations of an organization and the application of the tool can be extremely time consuming.
- Gathering of relevant information required to conduct a value chain analysis can be difficult.
Conclusion
Value chain analysis is a very useful management tool that helps to identify key activities which yields to the creation of superior product or service that is of high value to the customer. The analysis helps to maximize profits by creating superior product or service for which the customers are willing to pay a premium price, that exceeds the cost of production. Michael Porter created this useful model through which work products are broken down into various activities, which allows the management to focus on the truly useful activities that creates value to the organization. The value chain analysis also adds to the competitive advantage strategy of the company, helping to determine the vision and set direction for future products and services. The analysis also validates the supporting activities, which are often overlooked but are integral part to the value chain and value proposition of a company. However, as it is the case with most academic frameworks, the high level of complexities in todays business operations and the wide array of stakeholders involved makes it difficult for a firm to obtain the right data in order to conduct an effective analysis. Moreover, the process in itself is highly time consuming, limiting its practicality in today's business operations.
References
- ↑ 1.0 1.1 1.2 1.3 1.4 Porter, M.E. (1985) Competitive Advantage: Creating and Sustaining Superior Performance, Simon & Schuster
- ↑ 2.0 2.1 www.themanager.org, Dagmar Recklies, 2001, Recklies Management Project GmbH
- ↑ 3.0 3.1 http://www.investopedia.com/articles/investing/111014/basics-value-chain-analysis.asp
- ↑ 4.0 4.1 4.2 4.3 Deloitte (2004), “Unlocking the value of globalisation. Profiting from continuous optimisation”, A Deloitte Research Global Manufacturing Study
- ↑ 5.0 5.1 5.2 5.3 Undisclosed author, "Value Chaing Analysis," http://www.mindtools.com/pages/article/newTMC_10.htm
- ↑ Hergert, M. and Morris, D. (1989), Accounting data for value chain analysis. Strat. Mgmt. J., 10: 175–188.
- ↑ Stabell, C. B. and Fjeldstad, Ø. D. (1998), Configuring value for competitive advantage: on chains, shops, and networks. Strat. Mgmt. J., 19: 413–437.
Annotated Bibliography
Competitive Advantage: Creating and Sustaining Superior Performance (1985), By Michael Porter. Michael Porter introduced the concept of separating a company into activities and aligned each activity with supporting parameters that represented the building blocks of competitive advantage in this book. The powerful framework introduced in this book has guided multiple businesses, researchers and business schools to understand the roots of competition.
