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Subject COMMERCE

Paper No and Title 12. STRATEGIC MANAGEMENT

Module No and Title 15. Value Chain Analysis

Module Tag COM_P12_M15

COMMERCE PAPER No.12 : Strategic Management

MODULE No.15 : Value Chain Analysis
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TABLE OF CONTENTS

1. Learning Outcomes
2. Introduction
3. Main Aspects of Value Chain Analysis
4. Steps in Value Chain Analysis
5. Identifying Value Activities
5.1 Primary Activities
5.2 Support Activities
6. The Value Chain Approach for Assessing Competitive Advantage
6.1 Cost Advantage
6.2 Differentiation Advantage
7. The Value Chain System for an Entire Industry
8. Benchmarking: A Tool for Assessment
9. Strategic Options for Remedying a Disadvantage in Efficiency or Effectiveness
9.1 Improving the Efficiency and Effectiveness of Internally performed
Value Chain Activities
9.2 Improving the Efficiency and Effectiveness of Supplier-Related
Value Chain Activities
9.3 Improving the Efficiency and Effectiveness of Distribution-Related
Value Chain Activities
10. Summary

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1. Learning Outcomes

After studying this module, you shall be able to

 Know about the concept of value chain analysis

 Understand how to use it for generating competitive advantage
 Learn the concept of industry value chain analysis and value system

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2. INTRODUCTION

The value chain method was established by Michael Porter in the1980s in his famous
book “Competitive Advantage: Creating and Sustaining Superior Performance”. The
conception of value added, in form of the value chain, can be used to improve an
organization’s sustainable competitive in the business arena of the 21st century. All
organizations contains activities that tie together to develop the value of the business, and
collectively these activities form the organization’s value chain. The value chain structure
has been used as a influential analysis tool for the strategic planning of a firm for closely
two decades. The goal of the value chain framework is to maximize value creation and
minimize costs.

3. MAIN ASPECTS OF VALUE CHAIN ANALYSIS

Each organization is a pool of activities that are done to design,produce, market, deliver,
and support its product. All these activities can be exemplified using a value chain. In
competitive terms, value is the amount buyers are willing to pay for what a firm provides
them. It is measured by total revenue, a mirror image of the price a firm’s product
commands and the units it can sell. A firm is lucrative if the value it commands surpasses
the costs involved in creating the product.
The Value Chain Analysis was established to evaluate physical assets in product
environments. Other authors altered the model to accommodate service organizations and
intangible assets.
The value chain shows total value, and contains of value activities and margin. Value
activities are the technologically and physically distinct activities a firm performs. These
are the basic building blocks by which a firm creates a valuable product for its buyers.
Margin in business terms means the excess of total value over the collective cost of
performing the value activities.
Though it might appear that the value chain of organizations in a similar industry is
somewhat related but the value chains often differ. These differences amongst competitor
value chains are a vital source of advantage in terms of competition.

4. STEPS IN VALUE CHAIN ANALYSIS

The foremost step in conducting the value chain analysis is to break down the main
activities of the company according to the activities necessitated in the framework. They
can be divided into two broad types, primary activities and support activities. Activities
related to physical creation of the product are termed as Primary Activities. It also
includes sale and transfer to the buyer as well as after-sale assistance. Support activities
basically act as sporting activities to the primary ones. Within every class of main and
support activities there are three types of activities that play a diverse role in the strategic
competitive advantage. The image shows the three types of activities.
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The next step is to measure the potential for adding value through the means of cost
advantage or differentiation.
Lastly, it is imperative for the specialist to determine strategies that lays emphasis on
those activities that will allow the company to attain sustainable competitive gains
compared to its rivals.
Value activities are therefore the discrete building blocks of competitive advantage. How
each activity is accomplished combined with its economics will govern whether a firm is

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high or low cost compared to competitor and will also

determine its contribution to buyer needs and hence differentiation.

5. Identifying Value Activities

Ascertaining value activities needs the segregation of activities that are technologically
and strategically different.

5.1 Primary Activities

The primary activities can be categorized in five heads depending on any industry. Each
group is divisible into a number of separate activities that depend on the particular
industry and firm strategy:

Inbound logistics. Activities associated with the reception, storing and delivery of
materials necessary to create the product, such as materials handling, storing, stocks
financial administration, vehicles and returning to suppliers planning.

Operations. Activities associated with raw materials turning into final products
activities, such as processing, packing, assembling, installations maintaining, testing, and
endowment exploitation operations.

Outbound logistics. Activities associated with taking, storing and physical delivery of
the product to the buyers, such as final products storing, materials handling, delivery
vehicles exploitation, orders taking and operations planning.

Marketing and Sales. Activities associated with product delivery and buyers involving,
such as advertising, promotion, sales staff, offers, channels choosing, relations with
distributors and price setting up.

Service. Activities associated with service ensuring in order to increase or maintain the
product value, such as installation services, repairs, training, supplying spare parts and
product fixing.

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Figure 1: A Representative Company Value Chain

5.2 Support Activities

Support value activities involved in competing in any industry can be divided into four
generic categories. As with primary activities, each category of support activities is
divisible into a number of distinct value activities that are specific to a given industry.

Firm infrastructure. Firm’s infrastructure consists in a number of activities that involve

general management, planning, financial management, accountancy, legal assistance,
relations with state authorities and quality management; unlike other support activities, it
usually encourages the whole value chain, not individual activities.

Human resources management. Human resources management comprises in events such

as employing,training,recruiting, and paying all kinds of staff. It encourages both central
activities and for the support of individual (for example: training of employee), as well as
the whole value chain (for example: labour contracts negotiation). Human resources
management aims to influence the competitive benefit in any firm, through the role it
plays in determining employing and training costs as well as in determining professional
competence and employees’ motivation.
Technology development. Every value activity includes technology in one sense or
another: know-how, proceedings or technology included in processing installations. It
includes a wide gamut of activities that can be divided in efforts of improving the product
and the processing method. The development of the technology related to the product and
to its features supports the whole value chain, while, other types of technological
progress are associated to some definite activities, main or support activities.

Procurement refers to the purchasing function. Among purchased materials one can
mention: raw materials, auxiliary production materials and other consumable articles, as
well as assets such as equipments, laboratory installations, office devices and buildings.

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6. The Value Chain Approach for Assessing Competitive Advantage

The firm's margin or profit then depends on its effectiveness in performing these
activities efficiently, so that the amount that the customer is willing to pay for the
products exceeds the cost of the activities in the value chain. It is in these activities that a
firm has the opportunity to generate superior value. A competitive advantage may be
achieved by reconfiguring the value chain to provide lower cost or better differentiation.
The value chain model is a useful analysis tool for defining a firm's core competencies
and the activities in which it can pursue a competitive advantage as follows:

Cost advantage: by better understanding costs and squeezing them out of the value-
adding activities.
Differentiation: by focusing on those activities associated with core competencies and
capabilities in order to perform them better than do competitors.

Table 1 lists all the steps needed to achieve cost or differentiation advantage using value
chain analysis.

Table 1: Achieving Cost or Differentiation Advantage using Value Chain Analysis.

Cost advantage Differentiation advantage

This approach is used when organizations try to
The firms that strive to create
compete on costs and want to understand the
superior products or services use
sources of their cost advantage or disadvantage and
differentiation advantage approach.
what factors drive those costs.
 Step 1. Identify the firm’s primary and
 Step 1. Identify the
support activities.
customers’ value-creating
 Step 2. Establish the relative importance of
activities.
each activity in the total cost of the product.
 Step 2. Evaluate the
 Step 3. Identify cost drivers for each
differentiation strategies for
activity.
improving customer value.
 Step 4. Identify links between activities.
 Step 3. Identify the best
 Step 5. Identify opportunities for reducing
sustainable differentiation.
costs.

6.1 Cost Advantage

Organizations use the value chain approach to identify sources of profitability and to
understand the cost of their internal processes or activities. To gain cost advantage a firm
has to go through 5 analysis steps:

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Step 1. Identify the firm’s primary and support activities. All the activities (form
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.

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 (ABC) 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. The next step of internal cost analysis is
to identify the factor or cost determinants for each value creating process. By
understanding what factors drive costs, a firm can assign priorities among its cost
improvement initiatives. Different activities will have different cost drivers. Porter
identified 10 cost drivers related to value chain activities:
 Scale (economies of scale)
 Learning (experience leads to efficiency and reduce cost)
 Capacity Utilization
 Linkages among activities (connections between the different activities)
 Interrelationships among business units (connections across business units)
 Vertical integration (activities are outsourced or in-house)
 Timing (in case of fast moving markets)
 Policies (of cost or differentiation)
 Location
 Institutional Factors (laws, regulations, unions, taxes)
In order to determine its relative cost advantage, a firm should also know the cost
factors of its competitors.

Step 4. Identify links between activities. While individual value activities are
considered separate and discrete, they are not necessarily independent. Most activities
within a value chain are interdependent. Firms must not overlook value chain linkages
among interdependent activities that may impact their total cost. For example, cost
improvement programs in one value chain process may lower or increase costs and/or
revenues in other processes.
As sources of competitive advantage, these relationships or linkages among activities can
be as important as the activities themselves. Such linkages may also offer sustainable
competitive advantage, because their subtle, complex nature makes them difficult for
competitors to imitate. Therefore identifying the links between activities will lead to
better understanding how cost improvements would affect he whole value chain.

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. Some
processes may offer more opportunities for improvement than others. In order to get the

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most out of its cost reduction programs, a company should

prioritize its value-creating processes. When the company knows its inefficient activities
and cost drivers, it can plan on how to improve them. Companies can use comparisons
with best practices, benchmarking and business process redesign to reduce their costs.

6.2 Differentiation Advantage

The value chain approach is also used by organizations to identify opportunities for
creating and sustaining superior differentiation. In this situation, the primary focus is on
the customer’s perceived value of the products and services. Value Chain Analysis is
done differently when a firm competes on differentiation rather than costs. This is
because the source of differentiation advantage comes from creating superior products,
adding more features and satisfying varying customer needs, which results in higher cost
structure. A differentiation analysis is carried out using the following guidelines:

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. The key
to successful differentiation under the value-chain approach is to identify the value-
creating processes that distinguish a firm’s products or services from those of its
competitors. In making this distinction, customer value is emphasized. The ways
customer value can be enhanced through differentiation include:
 product features—that are esthetically appealing or functionally superior;
 marketing channels—that provide desired levels of responsiveness, convenience,
variety and information;
 service and support—tailored to end-user and channel member sophistication and
urgency of need.
 brand or image positioning—that lends greater appeal to the company’s offerings
on critical selection criteria; and
 price—including both net purchase price and cost savings available to the
customer through the use of the product and service.

Step 3. Identify the best sustainable differentiation. For a firm to achieve superior
differentiation, it must utilize the best mix of resources in creating value for its
customers. In order to prioritize its processes as sources of differentiation, a company
must determine what attributes of each process enhance customer value. The more unique
a firm’s resources and skills, the more sustainable is its differentiation advantage over
competitors.

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7. THE VALUE CHAIN SYSTEM FOR AN ENTIRE INDUSTRY

A company’s value chain is embedded in a larger system of activities that includes the
value chains of its suppliers and the value chains of whatever distribution channel allies it
utilizes in getting its product or service to end users. In contrast to the “value chain”,
which considers value added within a business, the value system extends the value chain
beyond the boundaries of the business and recognises that a business is dependent on
relationships with suppliers and buyers.
This value chain system has implications that extend far beyond the company’s costs. It
can affect attributes like product quality that enhance differentiation and have importance
for the company’s customer value proposition as well as profitability.
Suppliers’ value chains are regarded as the most appropriate because suppliers
accomplish several activities and incur huge costs in creating and delivering the
purchased inputs employed in a company’ own value-creating activities. The
performance features, costs, and quality of these inputs effect a company’s private costs
and product differentiation abilities. Any step undertaken by a company to help its
suppliers helps to drive down costs of the firm and of their value chain activities or
improve the quality and performance of the items being supplied can boost its own
competitiveness- a great reason for working collaboratively with suppliers in managing
supply chain activities.

Figure 2: Representative Value Chain System for an Entire Industry

Similarly, the value chains of distribution channel partners are relevant because (1) the
costs and margins of a company’s distributors and retail dealers are part of the price the
consumer ultimately pays, and (2) the activities that distribution allies perform affect
customer satisfaction. For these reasons, companies normally work closely with their

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suppliers and forward channel allies to perform value

chain activities in mutually beneficial ways.
As a consequence, accurately assessing a company’s competitiveness requires that
company managers understand an industry’s entire value chain system for delivering a
product or service to customers, not just the company’s own value chain. A typical
industry value chain that incorporates the activities, costs, and margins of suppliers and
forward channel allies (if any) is shown in Figure 2.
However, industry value chains vary significantly by industry. For example, the primary
value chain activities in the bottled water industry (spring operation or water purification,
processing of basic ingredients used in flavored or vitamin-enhanced water, bottling,
wholesale distribution, advertising, and retail merchandising) differ from those for the
computer software industry (programming, disk loading, marketing, distribution).

8. BENCHMARKING: A TOOL FOR ASSESSMENT

Once a company has developed good estimates for the costs and effectiveness of each of
the major activities in its own value chain and has sufficient data relating to the value
chain activities of suppliers and distribution allies, then it is ready to explore how it
compares on these dimensions with key rivals. This is where benchmarking comes in.
Benchmarking entails comparing how different companies perform various value chain
activities—how materials are purchased, how inventories are managed, how products are
assembled, how customer orders are filled and shipped, and how maintenance is
performed—and then making cross-company comparisons of the costs and effectiveness
of these activities.
Analysts can explore various sources to find information necessary for conducting
benchmarking. Sometimes benchmarking can be accomplished by collecting information
from published reports, trade groups, and industry research firms and by talking to
knowledgeable industry analysts, customers, and suppliers. Sometimes field trips to the
facilities of competing or noncompeting companies can be arranged to observe how
things are done, compare practices and processes, and perhaps exchange data on
productivity and other cost components.
The objectives of benchmarking are to identify the best practices in performing an
activity and to emulate those best practices when they are possessed by others. This
approach is used by many good companies to better their capabilities, and ultimately their
competitive advantage.

9. STRATEGIC OPTIONS FOR REMEDYING A DISADVANTAGE

IN EFFICIENCY OR EFFECTIVENESS

The construction of a value chain is a valuable tool for competitive diagnosis because of
what it reveals about a firm’s overall cost/value competitiveness and the relative
cost/value positions of firms in the industry. Examining the makeup of one’s own value

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chain and comparing it against the chains of important

rival firms indicates who has the most efficient and/or effective activities or competitive
advantages and capabilities.
There are three main areas in a company’s overall value chain where important
differences in the efficiency and effectiveness of competing firms can occur: (1) a
company’s own internal activities, (2) the suppliers’ part of the industry value chain, and
(3) the forward channel portion of the industry chain.

9.1 Improving the Efficiency and Effectiveness of Internally performed Value Chain
Activities

When a company’s cost disadvantage stems from performing internal value chain
activities at a higher cost than key rivals, then managers can pursue any of several
strategic approaches to restore cost parity:

1. Implement the use of best practices throughout the company, particularly for high-
cost activities.
2. Try to eliminate those cost-producing activities altogether that add little or no
customer value by revamping the value chain.
3. Relocate high-cost activities (such as manufacturing) to geographic areas like China,
Latin America, or Eastern Europe where they can be performed more cheaply.
4. See if certain internally performed activities can be outsourced from vendors or
performed by contractors more cheaply than they can be done in-house.
5. Invest in productivity enhancing, cost-saving technological improvements (robotics,
flexible manufacturing techniques, state-of-the-art electronic networking).
6. Redesign the product and/or some of its components to facilitate speedier and more
economical manufacture or assembly.

To improve the effectiveness of its customer value proposition and enhance

differentiation, there are several approaches a manager can take:

1. Implement the use of best practices for quality throughout the company, particularly
for high-value activities (those that are important for creating value for the customer).
2. Adopt best practices and technologies that spur innovation, improve design, and
enhance creativity.
3. Implement the use of best practices in providing customer service.
4. Relocate resources to devote more to activities that will have the biggest impact on
the value delivered to the customer and that address buyers’ most import purchase
criteria.
5. For intermediate buyers (distributors or retailers, for example), gain an understanding
of how the activities the company performs impact the buyer’s value chain. Improve the
effectiveness of company activities that have the greatest impact on the efficiency or
effectiveness of the buyer’s value chain.

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6. Adopt the best practices for signaling the value of the

product and for enhancing customer perception.

9.2 Improving the Efficiency and Effectiveness of Supplier-Related Value Chain

Activities

Improving the efficiency and effectiveness of the value chain activities of suppliers can
also address a company’s competitive weaknesses with respect to costs and
differentiation.
Supplier-related cost disadvantages can be attacked by pressuring suppliers for lower
prices, switching to lower-priced substitute inputs, and collaborating closely with
suppliers to identify mutual cost-saving opportunities. In a few instances, companies
may find that it is cheaper to integrate backward into the business of high-cost suppliers
and make the item in-house instead of buying it from outsiders.
Similarly, a company can enhance its differentiation by working with or through its
suppliers to do so. Some methods include selecting and rating suppliers who meet higher
quality standards, coordinating with suppliers to enhance design or other features desired
by customers, providing incentives to encourage suppliers to meet higher-quality
standards, and assisting suppliers in their efforts to improve.

9.3 Improving the Efficiency and Effectiveness of Distribution-Related Value Chain

Activities

There are three main ways to combat a cost disadvantage in the forward portion of the
industry value chain: (1) Pressure dealer-distributors and other forward channel allies to
reduce their costs and markups; (2) work closely with forward channel allies to identify
opportunities to reduce costs; and (3) change to a more economical distribution strategy
or perhaps integrate forward into company-owned retail outlets.
The means to enhance differentiation through activities at the distribution end of the
value chain system include (1) engaging in cooperative advertising and promotions with
forward allies (dealers, distributers, retailers, etc.), (2) creating exclusive arrangements
with downstream sellers or other mechanisms that increase their incentives to enhance
delivered customer value, and (3) creating and enforcing standards for downstream
activities and assisting training channel partners in business practices.

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10. Summary

 Porter’s value chain framework has been widely used as a powerful analysis tool
for organizational strategic planning for nearly two decades now.
 It was developed to analyse physical assets in product environments. Other
authors amended the model to accommodate intangible assets and service
organisations.
 The value chain structure shows that the value chain of a company may be useful
in identifying and understanding crucial aspects to achieve competitive strengths
and core competencies in the marketplace.
 The model also reveals how the value chain activities are tied together to
ultimately create value for the consumer.
 The five primary activities and four support activities form an interdependent
system that is connected by linkages. Analysts conducting the value chain
analysis should break down the key activities of the company according to the
activities entailed in the framework, and assess the potential for adding value
through the means of cost advantage or differentiation.
 It is important to determine strategies that focus on those activities that would
enable the company to attain sustainable competitive advantage. It is important to
analyse the value chain of a company with the core competence at its very heart.
 The firm may claim to have a competitive advantage gained long its value chain
only when its customers see the value provided by the firm as superior to that
offered by its competitors.
 Looking for sustainable competitive advantage, the firm should not limit only to
its own value chain, but it also should have in view the value chains of suppliers,
distributors and, finally, of its customers. Thus value supplying network takes
form, which consists in the firm, suppliers, distributors, and, finally, customers,
that form a “partnership” with one another in order to improve the whole system
performance.

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