Michael Porter published the Value Chain Analysis in 1985 as a response to criticism that his Five Forces framework lacked an implementation methodology that bridged the gap between internal capabilities and opportunities in the competitive landscape. This framework focused on industry attractiveness as a determinant of the profit potential of all companies within that particular industry. However, significant differences in performance exist between companies operating within the same industry that can be explained either by the company’s participation in a successful strategic group or by a firm’s specific competitive advantages. Value Chain Analysis helped identify a firm’s core competencies and distinguish those activities that drive competitive advantage. The cost structure of an organisation can be subdivided into separate processes or functions assuming that the cost drivers for each of these activities behave differently. When the value chain, used by the organization to develop a product, is capable of creating additional value but with no additional costs, a competitive advantage is realized. As shown in figure 1 below, Porter distinguishes two types of activities that constitute the value chain, primary activities and support activities. Primary activities:
These are line activities associated with production, transformation, delivery, and sales. They are classified into four main categories: Inbound Logistics: are activities involved in receiving, storing, and provisioning the inputs needed to deliver a product. They include warehousing and control of materials and inventory. Inbound logistics: materials handling, warehousing, inventory control, transportation; Operations: are activities that package, maintain, and transform inbound logistics into the final product. These activities can lead to differentiation and lower costs if performed in an efficient manner. Operations: machine operating, assembly, packaging, testing and maintenance; Outbound Logistics: are activities that pick, pack, store, and deliver the finished product to the end customers. Outbound logistics: order processing, warehousing, transportation and distribution;
Marketing and Sales: are activities involved in advertisement, promotion, distribution channel management, marketing and sales of products. They ensure all customer needs are considered in order to develop better future products. Marketing and sales: advertising, promotion, selling, pricing, channel management; Service: are activities that maintain and improve the value of the product to the customers by providing installation, repair, training, and supporting services after delivery. Service: installation, servicing, spare part management; Support activities:
These activities support the primary activities and include human resource management, procurement, technology development, and organizational infrastructure. Procurement: are activities involved in purchasing raw materials, supplies, and fixed assets (equipment, machinery) and transmitting them across the value chain. Procurement: purchasing raw materials, lease properties, supplier contract negotiations. Technology Development: are activities including R&D, design, processing, and servicing of the product manufacturing process and the product itself. Technology development: research & development, IT, product and process development;
Human Resource Management: are activities involved in recruiting, training, developing, empowering, and rewarding employees. Human resource management: recruitment, education, promotion, reward systems; Organizational Infrastructure: are activities including finance, accounting, planning, legal, governmental, and quality, and general management matters. Firm infrastructure: general management, planning, finance, legal, investor relations; Support activities if used efficiently can help in achieving differentiation and in lowering production costs. For example, human resource management needs to ensure staff is properly trained, motivated and rewarded for value creation. Organizational infrastructure activities should support the value chain and facilitate implementation of business strategies by identifying internal and external opportunities and threats. Technology development activities can bring product differentiation by introducing improvements to the development process. Finally cost-effective procurement activities that look for the most reliable suppliers with the best quality of goods can significantly reduce costs and create more value. By subdividing an organisation into its key processes or functions, Porter was able to link classical accounting to strategic capabilities by using value as a core concept, i.e. the ways a firm can best position itself against its competitors given its relative cost structure, how the composition of the value chain allows the firm to compete on price, or how this composition allows the firm to differentiate its products to specific customer segments.
Achieving Competitive Advantage with Value Chain
The value chain helps an organization in understanding where value is created at each of its activities and in linking those value-adding activities with the business strategy and customer needs. This set of activities which represents a unique and integrated value-creating sequence is hard for competitors to emulate and thereby sets up and maintains a long lasting competitive advantage for the organization. For example, The Warehouse Group Limited, the largest store retailer in New Zealand, has achieved and sustained competitive advantage over its rivals (Briscoes, Farmers, and Kmart) through executing and maintaining a set of valuable activities such as its well-developed buying function, state-of-the-art distribution centre in Auckland, cross-functional integration, technology investments, well-reputed people management, and its capability in identifying and controlling strategic retail sites.
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. I’ve written about this in Using The Value Chain To Create Competitive Advantage. 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. The book, Competitive Advantagewas published in 1985. 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. If you’re interested in this aspect of the value chain, watch theValue Chain Videos for an easy to understand introduction.
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. Michael Porter’s book is excellent but it is a tough read. It’s also dated in its examples which can make some of the ideas more difficult to relate to and understand how things fit together in the Internet age. 6. 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. 7. Business information systems are often not structured in a way to make it easy to get information for value chain analysis.
Value Chain Analysis provides a generic framework to analyse both the behaviour of costs as well as the existing and potential sources of differentiation.
Porter emphasised the importance of (re)grouping functions into activities to produce, market, deliver and support products, to think about relationships between activities and to link the value chain to the understanding of an organisation’s competitive position.
The value chain made clear that an organisation is multifaceted and that its underlying activities need to be analysed to understand its overall competitive position. An organisation’s strengths and weaknesses can only be identified in relation to the profiles of its direct competitors. Competitive advantage is derived from an integrated set of decisions on these key activities.
The Value Chain model was intended as a quantitative analysis. It can also be used as a quick scan to describe the strengths and weaknesses of an organisation in qualitative terms.
With the Value Chain Analysis, Porter tried to overcome the limitations of portfolio planning in multidivisional organisations. The concept of Strategic Business Units stated that businesses within a conglomerate should act independently while headquarters should be responsible only for budgetary decisions to be based on a business unit’s position in the overall portfolio. Porter used his Value Chain Analysis to identify synergies or shared activities between Strategic Business Units and to provide a tool to focus on the whole rather than on the parts.
The quantitative analysis is time consuming since it often requires recalibrating the accounting system to allocate costs to individual activities. Porter provided qualitative guidance for a quantitative exercise. His analysis began with identifying the relevant activities that lead to competitive differences and are significant enough to influence the organisation’s overall cost base.
The Value Chain Analysis should be accompanied with a customer segmentation analysis to mix the internal and external view. A feature or product provides the firm with a differentiating competitive advantage only if customers are willing to pay for it. Customer value chains need to be analysed to determine where value is created.
The Value Chain is used to analyse a firm’s position in relation to its direct competitors with the assumption that rivalry drives profitability. This excludes other assumptions such as customer bonding in Alexander Hax’s delta model.
The Value Chain Analysis was developed to analyse physical assets in product environments. Other authors amended the model to accommodate intangible assets and service organisations. Expert Group should answer the questions, grouped by units of the company’s value, while a score of 1 is the lowest, that is, statement or question do not correspond to the real situation, evaluation of 3 – partial match, 5 – full compliance, the highest rating. Answer the questions to be extremely honest, with a larger share of depreciation own capabilities in the analysis of the firm, and the exaggeration of features competitors. The results are entered into a drawing reflects the value chain of the enterprise. As a result , we are able to assess the real situation in the company , to identify points of possible growth , blocks inefficient use of capital, the value of action that determine the competitive face of the company and its competitive advantages. A graphical representation of the value chain together with the quantitative expert assessment allows inexperienced in matters related to competition by Russian entrepreneurs and managers to find their own competitive advantage and create a competitive enterprise .