Value Chain Analysis

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Value Chain Analysis

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Developed by Michael Porter, Value Chain Analysis is business management framework used to analyze the processes and key activities performed by a business or industry. This framework illustrates where value is created within an industry or company.

PORTER’S VALUE CHAIN ANALYSIS

SupportActivities

Primary Activities

Marketing /Sales

Outbound LogisticsOperationsInbound

LogisticsService / AfterSales Support

Firm Infrastructure

Human Resource Management

Technology Development

Procurement

2Questions & feedback? Email me – [email protected] diagrams in this pack are to be used by the original buyer only.

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Value Chain—introduction

What It Is

• A description of the processes and key activities performed either across an industry or across a company:

–Usually shown as a linear flow of activities

–A company’s Value Chain, also shows the support activities performed, e.g. systems support

• A Value Chain should show where value is being created within an industry or company:

–Should be quantitative, not qualitative.

–Should show the value of costs and revenues at each stage in the value chain.

• Value Chain Analysis identifies areas of competitive advantage or disadvantage

• Value Chain Analysis drives strategic hypotheses to answer several questions:

• Where are we, and our competitors, earning money? Why?

• Should we forward or backward integrate?

• Should we outsource or spin-off value activities (i.e. business processes)?

• What are the industry critical success factors?

• What are our managerial action plans to control costs, improve service and increase delivered value?

Strengths & Limitations

• Benefits:

-Provides a structure for performing competitive analysis by separating the value generating stages

-Aids in identifying critical cost drivers and non-value adding activities currently performed by your company

-Helps your company identify areas for improvement or potential competitive advantage by benchmarking cost drivers

-Allows your company to analyze opportunities for backward and forward integration by including suppliers and end-customers in the value chain

• Limitations:

-Value Chain Analysis requires considerable data collection

• Data not be readily accessible

• Other data difficulties include calculating transfer prices for intermediate products, isolating key cost drivers, identifying linkages across activities, and computing supplier and customer margins

-Comparisons with competitors is often very difficult

• Public data will not exist for privately held firms

• Subsidiaries of larger firms will often be aggregated with the parent’s information

a. In his book “Competitive Advantage”, Free Press.b. Forward integration is moving into activities closer to the starting activity within an industry.

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Value Chain—why we use it and how to apply it

Primary objective is to determine where value is created in an industry or company

Value Chains are also used to:

– Understand the key activities within an industry or company

– Determine whether there is any backward or forward integration in an industry

– Map key players at each stage of an industry’s value chain

– Map the customer’s experience at each stage in a company’s value chain

Michael Porter, in his 1985 book “Competitive Advantage,” outlines the following three steps in developing a value chain:

– Identify individual value activities:

• The appropriate degree of disaggregation depends on the economics of the activities and the purposes for which the value chain is being analysed

• Distinguish between primary and support activities

– Assign the value activities to the categories (or functions) that best represent their contribution to a firm’s competitive advantage

– Order the activities, broadly following the process flow:

• Determine the links between activities

Once the activities are detailed in the Value Chain, plot costs and players across the value chain where applicable

a. A Free Press publication.

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The Value Chain approach has evolved from an “internal” to an “external” perspective

The traditional view of the Value Chain was developed by Michael Porter:

Shank and Govindarajan propose a more externally focused, or holistic view of Value Chain Analysis

– Focus on the industry Value Chain (i.e. “value delivery system”)

– Identifies the activities performed by a firm and how those activities impact, and are impacted by, other players in the end-customer’s “value delivery system”

– Cost drivers are compared at each stage of the industry value chain to identify potential competitive advantages or opportunities

PORTER’S VALUE CHAIN ANALYSIS

SupportActivities

Primary Activities

Marketing /Sales

Outbound Logistics

OperationsInboundLogistics

Service / AfterSales Support

Firm Infrastructure



Procurement




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In the initial step, the value activities within the industry must be separated out

* The analyst should be careful to control scope at this point in the analysis.

Identify the industry value chain and map the linkages between the industry value activities

Assign costs, revenues and assets to value activities

Determine the relevant cost drivers for each value activity

Identify potential competitive advantages by either controlling cost drivers better than competitors or reconfiguring the value chain to better leverage the firm’s strengths

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STEP 1: Identify the Industry Value Chain and map the value linkages

The Industry Value Chain represents a linked set of value activities

Mapping the Industry Value Chain requires Identifying and separating these value activities

Each separate value activity becomes a different stage in the industry value chain*

Generally, a value activity should be separated out if:

– There is (or could be) an external market for the product or outcome of that activity

– The activity represents a significant percentage of operating costs

– The cost behavior of the activity or the cost drivers is different

– The activity is performed by competitors in different ways

– The activity has a high potential for creating differentiation




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An Industry Value Chain should include all competitors

Source: Shank and Govindarajan, 1993, Exhibit 4-2

Silvaculture andTimber Farming

Pulp Manufacturing

ConvertingOperations

Paper Manufacturing

Logging andChipping

Distribution

End-Use Customer

Com

petit

or A

Com

petit

or C

Com

petit

or D

Com

petit

or B

Com

petit

or F

Com

petit

or E

Com

petit

or G

Value Activities

Industry Value Chain Example – Paper Products Industry

Your company will face different competitors, with different cost structures, at each stage of the Value Chain.




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Each stage of the Industry Value Chain has associated primary and support activities

Com

petit

or X

* This additional detail could confuse the analysis, but would be required if vertical integration was being analyzed.

Industry Value Chain Example – Paper Products Industry (continued)

The level of analytical detail required depends on the strategic hypothesis being considered*.

Selection of Timberfor Harvest

General Management, Accounting, and Legal


Shipping and Tracking Systems

Purchasing Timber Rights

Logging andChippingOperations

ShippingSplit Woodto Pulp Mfg.

Quoting andPricing Wood Chip Output

Adapting to Outputand ShippingRequirements ofSpecific Pulp Mfg.

InboundWood Chips

General Management, Accounting, and Legal


Production and Shipping Technology

Purchasing of Wood Chips for Pulp

Pulp Mfg.Operations

Shipping ofPulp to Paper Mtg

Quoting andPricing Wood Chip Output

Adapting to Outputand ShippingRequirements ofSpecific Pulp Mfg.

COMPETITOR X VALUE DELIVERY SYSTEM




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A list of potential cost drivers is presented belowPotential Cost Drivers

SCALE Facility size Production technology Operating efficiency Run length Factory costs

LINKAGES Internal process linkages

Quality Output linkages (mfg. / distro.)

Vertical linkages Supplier imposed costs Supplier timeliness

DISCRETIONARY POLICY Product complexity Product variety R&D Marketing expenses Delivery time Inventory levels Segments served Production technology used Plant layout efficiency

INSTITUTIONAL FACTORS Government regulations Unionization Taxes, tariffs Local content rules

LEARNING Experience (cumulative output)

INTERRELATIONSHIPS Scope Other business units Shared activities Shared learning

TIMING First mover advantage Timing of input purchases

CAPACITY UTILIZATION Output level Facility utilization Seasonality Cyclicality Forecast accuracy

INTEGRATION Outsourcing Vertical integration Agency costs

LOCATION Transportation costs Labor costs Raw materials costs Energy costs




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The resulting Value Chain should drive strategic hypotheses Identify the industry value chain and map the linkages

between the industry value activities

Assign costs, revenues and assets to value activities

Determine the relevant cost drivers for each value activity

Identify potential competitive advantages by either controlling cost drivers better than competitors or reconfiguring the value chain to better leverage the firm’s strengths

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STEP 4: Identify potential competitive advantages by either controlling cost drivers better than competitors’ or reconfiguring the Value Chain to better leverage the firm’s strength

Closely analyze your company’s cost structure and position in the industry value chain relative to competitors:

– Calculate standard financial statistics at each value chain stage, based on inputs and assets (e.g. ROA, DuPont, EVA, etc.)

– Understand the basic economics of each value activity—Why do we do it? What are the key cost and value determinants?

– Identify strategies to improve cost and value performance in each stage

– Consider linkages between stages to help identify overall improvements

– Consider spin-offs and forward / backward integration to reconfigure your company’s Value Chain

– Consider threats and opportunities related to other chains which deliver substitute products or services to the ultimate customer




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There are three levels of detail for conducting and presenting Value Chain analysis

Source: Hax and Majluf, 1991.

Level 1: Qualitative Summary of Competitive TrendsExample

VALUE CHAIN ELEMENTS

STRATEGIC DIFFERENCES

AT&T NYNEX IBM

Procurement Owns manufacturing branch (Western Electric)

Free to use any supplier it wants Owns Rolm, CPE manufacturer


Technological leadership through Bell Labs

Focus on software products Strong R&D in computer hardware and software technologies

Operations National presence

High quality of equipment through heavy capital expenditures

Similar communications standards nationwide

Strongest national telecommunications network

Regional monopoly

Innovative equipment from outside suppliers

High quality regional network through heavy capital investment

Global presence

Leading computer technology

Partnership with MCI

Sales & Marketing

New emphasis on marketing (still weak)

Strong name and brand recognition

Long-term relationships with clients

Recruits computer executives

Use Bell logo

Focus on 1K coprorate customers

Sales and distribution centers close to customers

Strong reputation for marketing excellence

Already sells to most major corporations

Experience sales force




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Value Chain Analysis