Value Chain Analysis & Competitive Advantage- Guide for Businesses
Value chain analysis is the process of evaluating a business's internal activities to discover how it can gain and sustain a competitive advantage.
The rapid pace of technological advancement and globalization means that companies are more prone to disruptions than ever before.
According to research by McKinsey, these disruptions are far more common than most business owners think. On average, disruptions that last more than 100 days affect global value chains every five to seven years. Month-long disruptions are more frequent, happening every 3.7 years on average.
Unsurprisingly, such disruptions are costly. The research notes that companies can lose as much as 42% of a year's profits every decade due to unexpected problems in their value chain. All of this underscores the importance of value chain analysis - a strategic management tool for evaluating the business activities that go into creating a product or service.
What is Value Chain Analysis?
Introduced by Harvard Business School professor, Michael Porter, in 1985, the value chain model is a representation of all the business activities needed to create a product from start to finish. For example, a company that builds home furniture could have a value chain that comprises design, procurement of raw materials, production, and distribution.
Porter's value chain model organizes these internal activities into two categories-
- Primary Activities directly add value to the final product, such as operations and logistics
- Support Activities indirectly add value to the product, such as human resource management and tech development
A value chain analysis helps decision-makers understand which activities are most valuable and which ones could be optimized (perhaps even eliminated through technology and automation) to give the business a competitive advantage. By doing so, the firm can optimize primary activities that account for the greatest share of production costs and increase profit margins. Conversely, the analysis can also reveal support activities that could use more spending to generate better value.
At its simplest, however, a value chain analysis sheds light on a company's competitive advantages as well as its weaknesses and potential threats.
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How Businesses Can Gain Competitive Advantage
A competitive advantage is an attribute that sets a business apart from its competitors. While there are different ways for organizations to develop competitive advantages, almost all methods fall under two broad areas-
The challenge with product differentiation is that it takes a significant amount of time and money to research, develop, and manufacture a unique product. But when done correctly, a differentiation strategy allows the business to put a premium price on its offering and increase the profit margins.
- Cost Leadership
Businesses that implement a cost advantage strategy typically do so by making production activities as efficient as possible, using low-cost raw materials, and leveraging economies of scale to reduce the prices of their products or services.
While it is not unheard of for companies to have multiple competitive advantages, it is generally a good idea to focus on building a single competitive advantage.
Depending on an organization's approach, its value chain analysis goal will be either to lower costs or differentiate its offering. Either way, the analysis can help create a plan to improve efficiency and provide value to customers.
Understanding Primary and Support Activities in the Value Chain
According to Porter, the first step of starting a value chain analysis is to identify the primary and support activities that go into creating a product or service.
Primary activities that are directly involved in the creation and delivery of a final product may include-
1. Inbound Logistics - This is the process in which the goods or raw materials needed to develop the final product are brought to the business. Inbound logistics covers everything from transport, storage, and delivery of goods from other suppliers to the business.
2. Outbound Logistics - This process involves the distribution of a finished product or service. The offering can be delivered directly to customers or through a network of dealers, distributors, or retailers.
3. Operations - This refers to the process in which raw materials and resources are transformed into the final product or service.
4. Marketing and Sales - Just because a product or service exists, doesn't mean customers will automatically buy them. Marketing and sales activities make customers aware of the offering and compel them to make a purchase decision.
5. Services - These are ancillary solutions such as training, support, guarantees, and warranties, which enhance the product or service experience for customers.
Support activities help coordinate and support the functions of primary activities through purchased inputs, human resources, and technology.
1. Procurement - These activities cover the sourcing and purchasing of resources and materials required to develop a product. Procurement activities also include negotiating prices and maintaining relationships with suppliers.
2. Human Resource Management - Human resource management (HRM) covers all processes and systems involved in the managing of employees (e.g. attendance, payroll, and paid time off) and recruitment of staff. HRM is crucial for service-oriented businesses - where the customer experience rests on the shoulders of skilled employees.
3. Technology Development - These activities involve the acquisition and application of technology in the firm. Technology can be used across all value chain activities to improve efficiency and reduce costs, helping to give the business a competitive advantage.
4. Firm Infrastructure - This refers to the functions and systems that support the company's ability to maintain operations. Examples of firm infrastructure include legal, accounting, and administrative management.
How to Start a Value Chain Analysis
To identify and analyze their organization's value chain, business decision-makers can choose from two sets of steps, depending on how they develop their competitive advantage.
There are five steps to reducing the costs of internal business activities.
- Identify all primary and support activities - As mentioned earlier, companies must first identify the primary and support activities involved in creating and delivering goods and services.
- Determine the importance of each activity relative to product cost - The total cost of creating a product must be broken down and distributed across all internal business activities. Activities that account for a large percentage of total production costs should be addressed first.
- Identify each activity's cost drivers - Understanding how each activity uses the company's resources is the first step to making them more efficient and/or cost-effective.
- Note connections between activities - Identifying how activities are linked to one another allows the firm to understand each activity's role in the overall value chain. This can prevent problems such as cost reductions for one activity causing costs for a linked activity to increase.
- Identify cost-reduction opportunities - Businesses that know and understand their cost drivers and inefficient processes can make informed decisions about how to improve them.
Competing through differentiation means adding product features and improving customer satisfaction through these steps-
- Identify activities that drive customer value - This step involves identifying the activities with the biggest impact on customer-perceived value. For example, customers may see more value in a product that comes with excellent after-sales support.
- Assess differentiation strategies - Companies have a variety of differentiation strategies to choose from, such as adding product features, improving customer service, offering product customization, and creating complementary products and services.
- Choose a sustainable differentiation strategy - Differentiation activities can be cost-intensive. Organizations must find a balance between creating customer value and staying within budget.
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How Is Value Chain Analysis Applied in Different Industries?
Value chain analyses have become an important management tool across different industries. However, one company's perception of a value chain may be very different from another, especially when considering industry factors like technology, globalization, and corporate social responsibility.
- Logistics - A growing number of logistics firms have shifted to circular value chains that emphasize renewability. By incorporating renewable energy and sustainable packaging solutions into their facilities and operations, logistics companies can provide alternative solutions that meet their customers' sustainability needs.
- Non-Profit Organizations - Nonprofits like the United Nations Conference on Trade and Development (UNCTAD) and International Crops Institute for the Semi-Arid Tropics (ICRISAT) use value chain analyses to generate revenue and facilitate international cooperation to meet their overseas development missions.
- Food and Beverage - Sourcing quality ingredients, developing products with thin margins, and fostering loyalty through customer service are just a few of the many challenges today's food and beverage companies face. Value chain analysis allows these businesses to understand the variables that go into creating a positive product experience.
- Retail - Retail giants that depend on cost leadership constantly conduct value chain analyses to keep prices down and squeeze out as much profit through economies of scale, supplier partnerships, and marketing and sales campaigns. For premium retailers, value chain analysis can be the key to understanding customer preferences for high-end goods.
How to Make Value Chain Analysis Work
Admittedly, the scope of a value chain analysis can make it intimidating for the average project manager or ad-hoc committee. There are so many things to address, from identifying relevant tasks to narrowing down cost versus benefit factors. Below are a few techniques to get off to a good start.
- Make it a team effort - Project managers that identify and analyze activities on their own are likely to miss certain details that supervisors and team members are more familiar with.
- Conduct surveys and focus group discussions - Trusted customers with a history of purchases are the best source for insights on what kind of product and service experience they expect.
- Choose a competitive advantage - Decide early whether to aim for cost leadership or product differentiation as a competitive advantage.
- Leverage software automation - Using solutions such as supply chain and inventory management software can streamline operations by automating repetitive tasks. Inventory management platforms can also provide real-time visibility of stock levels and quickly identify patterns in demand and product movement. This is also useful for forecasting and reducing inventory holding costs.
- Work on tasks simultaneously - Another benefit of analyzing value chains as a team is that it allows different people to work on tasks simultaneously. Rather than analyzing the value chain in a linear way (i.e., one task at a time), companies can optimize their schedule by assigning team members to collaborate on interdependent tasks.
Conducting a comprehensive value chain analysis for the first time can feel like a daunting process. However, by involving as many key people as possible and using the right tools, business leaders can put the company in a better position to identify and bolster its competitive advantage.