Source: Porter (1985)
the word ‘margin’ for the difference between the total value and the cost of performing the value activities (Figure
1). Here, value is referred to as the price that the customer is willing to pay for a certain offering (Macmillan et al, 2000).
Other scholars have used the word ‘added value’ instead of margin in order to describe the same (Lynch, 2003).
The analysis entails a thorough examination of how each part might contribute towards added value in the company and how this
may differ from the competition.
In a study
of Saudi companies, Ghamdi (2005) found that 22% of the companies in the study used value chain frequently, while 17% reported
that they somewhat used it, and 42% did not use the tool at all. An interesting finding of the study was that the manufacturing
firms were frequent users of the tool compared to their service counterparts (Ghamdi, 2005).
How to write a Good Value Chain Analysis
of a company to understand its own capabilities and the
needs of the customers is crucial for a competitive strategy to be successful.
The profitability of a firm depends to a large extent on how effectively it manages the various activities in the value chain,
such that the price that the customer is willing to pay for the company’s products and services exceeds the relative
costs of the value chain activities. It is important to bear in mind that while the value chain analysis may appear as simple
in theory, it is quite time-consuming in practice. The logic and validity of the proven technique of value chain analysis
has been rigorously tested, therefore, it does not require the user to have the same in-depth knowledge as the originator
of the model (Macmillan et al, 2000). The first step in conducting the value chain analysis is to break down the key activities
of the company according to the activities entailed in the framework. The next step is to assess the potential for adding
value through the means of cost advantage or differentiation. Finally, it is imperative for the analyst to determine strategies
that focus on those activities that would enable the company to attain sustainable competitive advantage.
It is important
for analysts to remember to use the value chain as a simple
checklist to analyse each activity in the business with some depth (Pearson, 1999). The value chain should be analysed with
the core competence of the company at its very heart (Macmillan et al, 2003). The value chain framework is a handy tool for
analysing the activities in which the firm can pursue its distinctive core competencies, in the form of a low cost strategy
or a differentiation strategy. It is to be noted that the value chain analysis, when used appropriately, makes the implementation
of competitive strategies more systematic overall. Analysts should use the value chain analysis to identify how each business
activity contributes to a particular competitive strategy. A company may benefit from cost advantages if it either reduces
the cost of individual activities in the value chain or the value chain is essentially reconfigured, through structural changes
in the activities. One of the problematic areas of the value chain model, however, is that the costs of the different activities
of the value chain need to be attributed to an activity. There are few costing systems that contain detailed activity level
costing, unless an Activity Based Costing (ABC) system is in place in the company (Macmillan et al, 2003). Another relevant
area of concern that analysts must pay particular attention to is the customers’ view point of value. The customers
of the firm may view value in a generic way, thereby making the process of evaluating the activities in the value chain in
relation with the total price increasingly difficult. It is imperative for analysts to note that the overall differentiation
advantage may result from any activity in the value chain. A differentiation advantage may be achieved either by changing
individual value chain activities to increase uniqueness in the final product or service of the company, or by reconfiguring
the company’s value chain.
between a low cost strategy and differentiation in practice is unlike the rigidity that is provided regarding the same in
theory. Analysts must note that the difference between these two strategies is one of the shades of grey in real life compared
to the black and white that is offered in theory. For example, Emerson Electric, which is a cost leader, has quality as a
strategic concern in achieving its ‘best costs’ strategy (Pearson, 1999). Ivory Soap, a leading product of P&G, is a broad
differentiator that turned into a cost leader. Quality is a strategic concern for managers of Ivory Soap, along with delivering
a high value product consistently.
in a company with more than one product area, it is appropriate to conduct the value chain analysis at the product group level,
and not at the corporate strategy level. It is crucial for companies to have the ability to control and make most of their
capabilities. In the advent of outsourcing, progressive
companies are increasingly making their value chains more elastic and their organisations inherently more flexible (Gottfredson
et al, 2005). The important question is to see how the companies are sourcing every activity in the value chain. A systematic
analysis of the value chain can facilitate effective outsourcing decisions. Therefore, it is important to have an in-depth
understanding of the company’s strengths and weaknesses in each activity in terms of cost and differentiation factors.
of Wal-Mart worked
when the company improved its business through innovative practices in activities such as purchasing, logistics, and information
management, which resulted in the value offering of “everyday low prices” (Magretta, 2002). It is important to
note that refining business models on a constant basis is as critical to the success of the company as its business strategy.
Notably, both the strategy and business model of an organisation are crucial for the robustness of the overall value chain.
7-Eleven had been vertically integrated, controlling most activities in the value chain by itself. The company has now outsourced
many parts of its business including functions like HR, IT management, finance, logistics, distribution, product development,
and packaging. According to Gottfredson et al (2005), the value chain decisions of companies will increasingly shape their
the value chain decisions will play a role in determining the type of management skills that companies may need to develop
or acquire to survive in fiercely competitive business markets.
The Apple podcasting
value chain is comprised of nine steps that essentially move from raw content to the listener. All the steps of the value
chain include content, advertising, production, publishing, hosting/bandwidth, promotion, searching, catching, and listening.
It is important to note that each step in the value chain adds value to the podcast in distinctive ways, has its own sets
of challenges and opportunities.
It is important
to note that the nature of value chain activities differs greatly in accordance with the types of companies and industries.
For companies with complex systems like IBM, Accenture and Cisco etc., it
is not possible for one member of the value chain to provide all the products and services from start to finish. The marketing
function in such companies focuses on aligning with key partners and allies that must collaborate with each other. For example,
installing SAP's ERP system requires direct involvement from companies like HP, Oracle, and Accenture, along
with indirect involvement of companies like EMC, Cisco, and Microsoft, and collaboration
between many departments within the company. The market assets contrast starkly between the companies with complex systems
and those that are driven by volume operations. For example, in case of Apple’s
leading products like Macintosh and the iPod, the entire offer is inside a package, and the entire value chain is preassembled.
The change of supplier for the Macintosh from IBM, to Intel, improved
the system performance while retaining the value in terms of price to the consumer. The only variable to manage in Apple’s
case is the consumers’ preferences. The role of creating differentiation through unique quality features, along with
promotion in order to create brand awareness, image and eventually brand equity becomes imperative for volume operations driven
companies like Apple (Moore, 2005).
It is imperative
to note that the value chains of companies have undergone many changes over the last two decades, due to the rapidly changing
business environment. Information technology and the Internet have played a fundamental role in transforming certain parts
and the interlinkages between parts of the value chains of companies today. Moreover HRM is increasingly becoming a vital
asset in the value chain that contributes to competitive advantage. Strategic
alliances are also
becoming an integral part of the value chains. For example, IBM once enjoyed
backward vertical integration into the disk drive industry and forward vertical integration into the consulting services
and computer software industries (Hill et al, 2007). According to the changing business environment, IBM had more
than 400 strategic alliances as of 2003 (Thompson et al, 2003). Herein, the value chain analysis is useful in providing a
framework to examine the advantages that partners can give to each other (Pathania-Jain, 2001). It is important to note the
source of competitive advantage of a company for the value chain analysis. The competitive advantage for IBM, for example,
lies in depth, breadth and the geographic spread of its global operations (Rai, 2006) and the loyalty that the big blue enjoys
from its clientele.
should look for the managerial implications that the new era of capability outsourcing may bring. The value chain decisions
of companies will increasingly shape their organisational structure. Furthermore these decisions will determine the types
of managerial skills that companies may need to develop to survive in an increasingly competitive business environment.
Where to find information for Value Chain Analysis
can explore various sources to find information necessary for conducting the value chain analysis. Up to three years of annual
reports of the company can be analysed to see how the costing of the activities are changing over the period and whether they
are in unison with the competitive strategy of the firm. These annual reports of the company can be compared to the annual
reports of the key competitors in order to see how competitive strategies differ between the companies, along with finding
the difference in the contribution of activities to the company’s profitability.
In order to gain knowledge about
the core competence of the company, analysts can look at the company and competitor websites. SWOT analysis
of the companies done by companies like Datamonitor etc. can help the analyst to understand the key strengths and weaknesses
of the company and how the firm differs from its competitors. Furthermore, journal articles, trade publications and magazines
are useful sources of information to identify how value is created in the particular industry in which the company operates
and which activities play a key role in the generation of that value.
Limitations of Value Chain Analysis
One of the
limitations of the value chain model is that it describes an industrial organization which essentially buys raw materials
and transforms these into physical products. Notably, at the time when the model was introduced (Porter, 1985), service industries
in the western countries employed lesser workforce compared to today’s statistics of the same (www.wikipedia.org). Academics
and practitioners alike have critiqued the model and its applicability in the context of service organisations. Partnerships,
alliances and collaboration along with
differentiation and low costs are common drivers of value today.
of the model include the fact that ‘value’ for the final customer is the value only in its theoretical context
(Svensson, 2003), and not practical terms. The real value of the product is assessed when the product reaches the final customer,
and any assessment of that value before that moment is only something that is true in theory. Despite this limitation, analysts
can effectively use the value chain model to determine the value to the final customers in a theoretical way. Use of other
planning tools and techniques like Porter’s
generic strategies, analysis
of critical success factors etc. is recommended in conjunction with the value chain framework for a more comprehensive analysis
of a company’s strategy and planning.