Value Chain Analysis

Value Chain Analysis

Adding value link by link to make your business stronger.
By the end of this lesson, you are expected to:
• learn what the value chain is and what each of its components are.
• be able to use value chain analysis as an effective tool.
• understand the difference between vertical and horizontal integration.
What is the Value Chain?

The Value Chain represents the internal activities a firm engages in to produce goods and services (when transforming inputs into outputs).

In 1985, Michael Porter identified a set of interrelated generic activities common to a wide range of firms. The resulting model is known as the Value Chain.

It is a high-level model developed by Porter used to describe the process by which businesses receive raw materials, add value to the raw materials through various processes to create a finished product, and then sell that end product to customers.

What is the Value Chain?

To analyze the specific activities through which firms can create a competitive advantage, it is useful to model the firm as a chain of value-creating activities.

It is formed of primary activities that add value to the final product directly and support activities that add value indirectly.

Primary Activities
There are 5 Primary Value Chain Activities
(1) Inbound Logistics
This include the receiving, warehousing, and inventory control/management of input materials ready for production.
(2) Operations
The value-creating activities that transform the raw materials (inputs) into the final product or service.
(3) Outbound Logistics
The third activity in the value chain that occurs after all operations are completed and the end product is ready for the customer. 

The activities required to get the finished product to the customer are considered part of outbound logistics, including warehousing, order fulfillment etc.
(4) Marketing & Sales
Includes all strategies used to get potential customers to purchase a product, such as channel selection, advertising, pricing etc.
(5) Service
Service is the fifth and final step in a company’s value chain and describes all activities that maintain and enhance the product’s value, thus creating better consumer experiences. This includes customer support and repair services.
These five categories are generic and portrayed here in a general manner. Each generic activity includes specific activities that vary by industry.

The goal of these activities is to create value that exceeds the cost of providing the product or service, thus generating a profit margin.

Any or all of these primary activities may be vital in developing a competitive advantage.

For example, logistics activities are critical for a provider of distribution services, and service activities may be the key focus for a firm offering on-site maintenance contracts for office equipment.
Support Activities

The primary value chain activities described above are facilitated by support activities.

Support activities are often viewed as “overhead” costs, but some firms have successfully used them to develop a competitive advantage.

Porter identified four generic categories of support activities, the details of which are industry-specific:

(1) Procurement
The function of purchasing the raw materials and other inputs used in the value-creating activities.
(2) Technology
Includes research and development, process automation, and other technological development used to support the value chain activities.
(3) Human Resource Management
Activities associated with recruiting, development and compensation of employees.
(4) Firm Infrastructure
Includes activities such as finance, legal, quality management etc.
Increasing the efficiency of any of the four support activities increases the benefit to at least one of the five primary activities.
Value chain analysis
Value Chain Analysis (VCA) 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.

Companies conduct value-chain analysis by looking at every production step required to create a product and identifying ways to increase the efficiency of the chain. The overall goal is to deliver maximum value for the least possible total cost and create a competitive advantage.

Understanding the Tool

Value Chain Analysis is a strategy tool used to analyze internal firm activities. Its goal is 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.

In other words, by looking into internal activities, the analysis reveals where a firm’s competitive advantages or disadvantages are.

The firm that competes through differentiation advantage will try to perform its activities better than competitors would do. If it competes through cost advantage, it will try to perform internal activities at lower costs than competitors would do. When a company is capable of producing goods at lower costs than the market price or to provide superior products, it earns profits.

How to Use the Tool

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).

Differentiation Advantage
Value Chain Analysis is a useful tool for working out how you can create the greatest possible value for your customers.

It is a three-step process:
1) Activity Analysis: First, you identify the activities you undertake to deliver your product or service.

2) Value Analysis: 
Second, for each activity, you think through what you would do to add the greatest value for your customer.

3) Evaluation and Planning:
 Thirdly, you evaluate whether it is worth making changes, and then plan for action.

Why Use the Value Chain?

The concept of Value Chain helps to understand and segregate the useful (which help in gaining a completive edge) and wasteful activities (which hamper market lead) accompanying each step during the product development process.

It also explains that if value is added during each step, the overall value of the product gets enhanced, thus helping in achieving greater profit margins.

For more information on value chain analysis, refer to the following books:
– Competitive Advantage: Creating and Sustaining Superior Performance by Michael Porter
– Understanding Michael Porter: The Essential Guide to Competition and Strategy by Joan Magretta
[Optional] Starbucks As An Example Of The Value Chain Model
To see an example of how the Value Chain works, visit the link below:
http://www.investopedia.com/articles/investing/103114/starbucks-example-value-chain-model.asp
Vertical & Horizontal Integration
Industry vs. Firm Value Chain

A firm’s Value Chain (VC) is a part of a larger industry VC. The more activities a company undertakes compared to industry VC, the more vertically integrated it is.

Below, you can find an industry value chain and its relation to a firm level VC.

See full-size images here: http://bit.ly/2fPLHu9
Vertical Integration

Vertical Integration is a strategy used by a company to gain control over its suppliers or distributors in order to increase the firm’s power in the marketplace, reduce transaction costs and secure supplies or distribution channel.

Many companies use this strategy to gain control over their industry’s value chain. This strategy is one of the major considerations when developing corporate level strategy. The important question in corporate strategy is, whether the company should participate in one activity (one industry) or many activities (many industries) along the industry value chain.
Horizontal Integration

The process of acquiring or merging with competitors, leading to industry consolidation. Horizontal Integration (HI) is a strategy where a company acquires, merges with or takes over another company in the same industry value chain.

It is a type of integration strategy pursued by a company in order to strengthen its position in the industry. A corporate that implements this type of strategy usually merges with or acquires another company that is in the same production stage.

HI may be an effective strategy when:
– The organization competes in a growing industry.
– Competitors lack of some capabilities, competencies, skills or resources that the company already possesses.
– The organization has sufficient resources to manage M&A.

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