Concept of Value chain approaches

Introduction: The value chain approach was developed by Michael Porter in the 1980s in his book “Competitive Advantage: Creating and Sustaining Superior Performance” (Porter, 1985). The concept of value added, in the form of the value chain, can be utilized to develop an organisation’s sustainable competitive advantage in the business arena of the 21st C. All organisations consist of activities that link together to develop the value of the business, and together these activities form the organisation’s value chain. Such activities may include purchasing activities, manufacturing the products, distribution and marketing of the company’s products and activities (Lynch, 2003). The value chain framework has been used as a powerful analysis tool for the strategic planning of an organisation for nearly two decades. The aim of the value chain framework is to maximise value creation while minimising costs.

Main aspects of Value Chain Analysis

Value chain analysis is a powerful tool for managers to identify the key activities within the firm which form the value chain for that organisation, and have the potential of a sustainable competitive advantage for a company. Therein, competitive advantage of an organisation lies in its ability to perform crucial activities along the value chain better than its competitors. The value chain framework of Porter (1990) is “an interdependent system or network of activities, connected by linkages” (p. 41). When the system is managed carefully, the linkages can be a vital source of competitive advantage (Pathania-Jain, 2001). The value chain analysis essentially entails the linkage of two areas. Firstly, the value chain links the value of the organisations’ activities with its main functional parts. Then the assessment of the contribution of each part in the overall added value of the business is made (Lynch, 2003). In order to conduct the value chain analysis, the company is split into primary and support activities (Figure 1). Primary activities are those that are related with production, while support activities are those that provide the background necessary for the

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effectiveness and efficiency of the firm, such as human resource management. The primary and secondary activities of the firm are discussed in detail below.

Primary activities

The primary activities (Porter, 1985) of the company include the following: • Inbound logistics

These are the activities concerned with receiving the materials from suppliers, storing these externally sourced materials, and handling them within the firm. • Operations These are the activities related to the production of products and services. This area can be split into more departments in certain companies. For example, the operations in case of a hotel would include reception, room service etc. • Outbound logistics These are all the activities concerned with distributing the final product and/or service to the customers. For example, in case of a hotel this activity would entail the ways of bringing customers to the hotel. • Marketing and sales: This functional area essentially analyses the needs and wants of customers and is responsible for creating awareness among the target audience of the company about the firm’s products and services. Companies make use of marketing communications tools like advertising, sales promotions etc. to attract customers to their products. • Service

There is often a need to provide services like pre-installation or after-sales service before or after the sale of the product or service.

Support activities

The support activities of a company include the following: • Procurement

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This function is responsible for purchasing the materials that are necessary for the company’s operations. An efficient procurement department should be able to obtain the highest quality goods at the lowest prices. • Human Resource Management This is a function concerned with recruiting, training, motivating and rewarding the workforce of the company. Human resources are increasingly becoming an important way of attaining sustainable competitive advantage. • Technology Development This is an area that is concerned with technological innovation, training and knowledge that is crucial for most companies today in order to survive. • Firm Infrastructure This includes planning and control systems, such as finance, accounting, and corporate strategy etc. (Lynch, 2003). Figure 1 The Value Chain

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Source: Porter (1985)

Porter used 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).

The ability 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

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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

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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.

The difference 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. Note that 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.

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