Businesses seeking competitive advantage often turn to value chain models to identify opportunities for cost savings and differentiations in the production cycle. In an ideal situation, the value chain demonstrates that the cost to build is far lower than the cost the market can bear, but this is becoming more difficult as customer demands grow in complexity and as market competition increases. Additionally, technology and communication methods have changed greatly since Michael Porter introduced the value chain model in 1985. But even with progress and innovation, value chain analysis is still a sound model for identifying market opportunities and achieving competitive differentiation.
In this article, we will discuss how value chains require continuous reevaluation, reimagination, and remodeling to meet changing economic conditions. Once established, however, an efficient value chain can lead to great success.
Value chains streamline the processes that take a product from concept to market. The integral linkages are supported by both structure and effective communication between direct, indirect, and support components. Direct activities, such as hiring and training human capital, are further supported through appropriate indirect activities, such as record keeping and quality control.
When analyzing the effectiveness of a value chain model, the economist Michael Porter introduced the following 10 cost drivers that help identify areas for improvement:
Porter's Value Chain is a strategic management framework that analyzes a company's activities to identify its competitive advantage. It consists of the primary activities directly involved in production and delivery and the support activities that allow primary activities to be executed.
Profit models have a long history preceding value chain modeling. In 1758, Francois Quesnay authored Tableau Economique, one of the first published works on the subject. In the mid-20th century, Wassily Leontief outlined interconnectivity between industries through his input/output model. And in 1985, Michael Porter introduced a value chain that expanded Leontief’s input/output model by emphasizing links between primary and support business activities.
Porter’s value chain is a framework for developing an analytic structure that follows interdependent activities from raw material acquisition or idea through production and finally, into the hands of a customer. This model is as useful today as it was over 30 years ago because businesses in all industries have the ability to identify alliances or linkages between the discrete activities that contribute to their product development.
Discussions of value chains usually focus on the mechanics and framework of the process, but more information can be gained from analysis. Value chain analysis is where real market opportunities are identified. In Competitive Advantage of Nations, written in 1998, Michael Porter concluded that “firms gain competitive advantage from conceiving of new ways to conduct activities, employing new procedures, new technologies, or different inputs.”
Porter’s value chain involves five primary activities: inbound logistics, operations, outbound logistics, marketing and sales, and service. Support activities are illustrated in a vertical column over all of the primary activities. These are procurement, human resources, technology development, and firm infrastructure.
The generic value chain model visually represents all activities with equal weight. However, value chain analysis emphasizes the real needs of the company. For example, a company that assists after the sale, such as for copiers or air conditioners, has a larger service activity set than a company that performs little follow-up action, such as FedEx or UPS.
When using Porter’s value chain, you must identify whether you are trying to differentiate or lower costs, prioritize the changes you identify during analysis, and consider how changes will benefit the entire organization.
Prior to writing on value chain models, Porter developed a unique competitive analysis tool called Porter’s Five Forces. This tool takes a critical look at competitive market forces in an effort to identify opportunities or risk — it is similar to a SWOT (strengths, weaknesses, opportunities, and threats) analysis. Porter’s tool analyzes changing conditions in order to provide a structure for proactive improvement.
Below are the five forces:
Examples of improvements include innovation and cost containment opportunities, exclusive supplier agreements, improved geographic locations for ease of delivery, and the use of unique raw materials and manufacturing processes. This analysis goes beyond a simple identification of competitors; instead, it focuses on how their behaviors, relationships, or ease of market penetration puts pressure on the organization. This helps the organization assess its true market position, mitigate challenges, and find ways to keep up with, redefine, or overtake the competition.
Value chain modeling yields numerous benefits. In Competitive Advantage: Creating and Sustaining Superior Performance, Porter says, "Competitive advantage frequently comes from perceiving new ways to configure and manage the entire value system.”
Porter’s generic value chain model is both broad and complete, but it is not absolute. Rather, the model is adaptable to the unique needs of each organization. You can think of it as a starting point that demands analysis and adjustment as the marketplace evolves, the competition grows, technology is introduced, or customers demand change. For example, a value chain can help an organization identify in-house and outsourcing opportunities that take advantage of cost savings and specialized expertise.
Ultimately, value chain modeling offers the following benefits:
Anna Knezevic, Managing Director with M&A Solutions Ltd., says, “We use value chain analysis to identify client providers and attribute earnings to our contractors. This analysis helps us spot bottlenecks and make fast improvements.”
“M&A Solutions uses value chain analysis to identify client providers and attribute earnings to contractors. “If we know that someone adds ‘x’ value per every client, but the contractor has generated far less than ‘x,’ we can drill down to find the problem.” - Anna Knezevic, M&A Solutions Ltd.
Along with the value chain, business process management (BPM) can contribute to the success of a business. BPM takes a broad view of business practices, organization structure, purpose, and core strategies. It advocates end-to-end strategies that provide clarity of purpose, resource alignment, and process discipline, and now that technology is integrated into business initiatives rather than treated as a separate entity, BPM has changed dramatically. A value chain can boost this process by providing useful analysis of associated business activities in order to improve relationships and practices that keep customers satisfied.
The business model, coupled with an understanding of business capabilities, is the basis for the operational, technology, and information decisions that support a successful value chain system. The value chain model, while important, is only one part of a company’s overall business model or strategy.
Business Model
Value Chain Model
Provides a rationale and a plan for financial expenditures, which include increased emphasis on communication and technology
Models and illustrates the linkages needed to perform the discrete functions that keep customers buying products or services
The architecture that defines organizational structure, needed technology, customer identification, and internal culture
The mechanism to execute the processes
Through the prism of the linkages identified in a value chain model, a business can recognize cost relief and differentiations. The chain supports the business by following the inputs, building, and outputs that place a physical product into the hands of the end user. The value chain and business model are successful when processes are cost-effective, and they provide a desirable outcome that includes profitability, brand loyalty, and repeat business.
Value chains can be categorized by how they are used within and across an organization:
The question for most organizations is not whether they use a form of value chain modeling, but how well it is implemented and analyzed. Porter’s generic chain is easily adaptable to a host of industries, including manufacturing, retail, distribution, food/beverage service, technology, and construction, but it can apply to any company, especially those in highly competitive arenas who are seeking cost savings and differentiation opportunities. See the examples below:
The below sample takes Porter’s value chain model and inputs primary and support activities that may relate to a large retail establishment, such as Walmart. This sample template can be used as a guide for any organization in any vertical.
The examples of companies that use value chains are a “who’s who” of the world marketplace. You see Rolls-Royce, Starbucks, and McDonalds, along with names in every industry, including banking, farming, and communications.
But it is not just global enterprises that find competitive advantages through value chain modeling. Interdependent departments, including human resources, marketing, sales, procurement, customer service, and IT or cooperative value systems from suppliers to distributors, can find cost advantages and unique differentiations through their respective value chains. For example:
Even governments, world agencies, and humanitarian organizations use value chains to identify and optimize value propositions that are specifically constructed to combat poverty, provide economic relief, and build needed infrastructure, all while honoring and encouraging distinctive cultural practices. For example, tomato farmers in Ghana benefit from value chain analysis that includes geography, access to credit, government interference, and improved cultivation practices.
An organization can implement value chain analysis in numerous ways, but Porter’s model advocates for two elements: cost advantages and differentiation. If you decide to focus primarily on cost evaluations or differentiation opportunities, the generic value chain provides a strong starting point. However, there are also approaches that focus on both cost advantages and differentiation, and beyond:
This article has demonstrated valuable benefits that local, national, and international organizations experience through the four direct and five indirect activities of value chain modeling. But there are challenges. One of the biggest is the task of identifying thousands of direct and indirect tasks and activities that impact a value chain. The unique needs of individual organizations and industries cannot be templated, and as a result, identifying tasks and developing a plan can become extremely time-consuming.
A value chain is a tool for constructing relationships in order to identify profit areas and competitive differentiators. Unfortunately, a value chain is not static and demands constant attention, evaluation, and updating in order to keep up with business progress. As Michael Porter says, “Competitive advantage frequently comes from perceiving new ways to configure and manage the entire value system.” When Porter introduced the value chain, computers and mobile devices were not ubiquitous, yet the model has been adaptable to these new realities. It is up to the each organization to build and deploy a value chain that keeps pace with evolving technology, adapts to a changing workforce, and expands with the global economy.
Those working with or interested in value chain analysis can find a variety of professional organizations, best practices, tools, and methodologies dedicated to the topic.
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