Mtm11 white paper value chain analysis

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Value Chain AnalysisIntelligence Collaborative - Mastering the Methods Series

Value Chain Analysis

This White Paper is #11 in a series of intelligence methods being offered to members of the Intelligence Collaborative. It was developed by Dr. Craig S. Fleisher to provide a concise overview of how to apply key intelligence methods to support analysis. Although every effort is made to ensure that the information is accurate and fit for its purpose, the author and Aurora WDC make no implied or explicit warranties as to its applicability or use in your particular work context.

Please direct any questions about this paper to its author at the following:Craig S. Fleisher, Ph.D.

Aurora WDCEmail: [email protected]

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Other White Papers are available on a regular basis from http://IntelCollab.com. Related Methods in the series are:

Win/Loss Analysis


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Copyright ©2013 Intelligence Collaborative powered by Aurora WDC. To order copies or request permission to reproduce materials, please call Dr. Craig Fleisher at +1.608.630.5869, write to him at Intelligence Collaborative powered by Aurora WDC, 215 Martin Luther King Blvd #32, Madison, Wisconsin, 53701, USA or go to http://IntelCollab.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any other form or by any means – electronic, mechanical, photocopying, recording, or otherwise – without the permission of Intelligence Collaborative powered by Aurora WDC.




Abstract

Value chain analysis (VCA) is used to identify a company’s potential sources of economic advantage and to achieve an optimal allocation of resources. For our purposes, a value chain can be defined as the full range of sequential organizational activities that are needed to take products and services from the original idea all the way through the different stages of production. This includes the physical transformation and inputs of various producer services, delivery, and post-sale services to final customers. Value chains within a company or industry are actually composed of a specific model of performance characterizing the discrete stages of organizational value creation.

(Source: Porter, 1985)

The Method’s Primary Value

The unique strength of VCA is that it can be used to help companies bridge the strategic gaps between their capabilities - aspects of the business that employ resources effectively and perform well - and opportunities and threats in their competitive environments. Hence, VCA’s two main objectives are to identify opportunities to secure cost advantages and to create customer-satisfying product/service attribute differentiation. Cost advantages can be achieved by reconfiguring the entire value chain to lessen overall costs or the costs of any of the key activities along the chain. Likewise, differentiation can be achieved through value chain reconfiguration or by delivering innovative ways of generating higher value from a particular activity or set of linked activities.



Overview of the Method

Value chains are more complex than the simplified version shown on the prior page. In many cases, the input and output chains comprise more than one channel, and these channels can supply more than a single market. Porter classifies all these activities into two main categories.

1. Primary activities include the following (three of these primary activities are product-related):• Inbound logistics are activities in which resources are acquired for later processing by the

business, including such areas as inventory warehousing and handling.• Operations are activities that transform the gathered inputs into the final product or service.• Outbound logistics are distribution-oriented activities such as logistics and shipping.

Two of these activities are market-related:• Marketing and sales are all the activities designed to communicate the product’s or service’s

benefits to consumers, such as marketing communications, pricing, and channel management.• Services include post-sale support activities.

2. Support activities include all the important activities that cut across the company’s primary activities and provide ongoing infrastructure assistance for the rest of the organization. These activities differ by industry and company, but they generally include the following:• Firm infrastructure includes administrative support activities covering the range of primary

activities, such as accounting, legal, planning, and all forms of stakeholder relations, such as government and public affairs, communications, community investment, and investor relations.

• Human capital management includes aspects of the company and its human capital enhancement process, such as recruitment, incentive systems, motivation, training, promotion, and industrial/labor relations.

• Procurement includes activities such as funding, subcontracting, supplier management, and specification.

• Systems and technology includes infrastructure facets of the business that help design, develop, and/or deliver products more effectively and efficiently, such as engineering, R&D, and information technology.

Where the Method Fits in Planning and Strategy

From the company’s perspective, VCA is a highly practical tool for understanding its strengths and weaknesses. From an industry perspective, VCA provides a good understanding of the company’s competitive position relative to key customers and suppliers. VCA also helps you understand the nature and sustainability of the company’s resources and capabilities and what new resources and capabilities it might require to be competitive in the future. For those who perform a SWOT analysis as part of their insight development process, VCA provides a much better real-world sense of what is really a strength or a weakness.



VCA encourages the company to comprehensively review all the activities that deliver value to the customer. It is also more inclusive of the complex economic cost drivers that affect customer value. These include structural drivers (scale, scope, experience, technology, complexity) and executional drivers (management style, total quality management, plant layout, capacity utilization, product configuration, vertical links with suppliers and customers).

For an organization to develop and execute a successful product, it is essential that it add value in each activity that the product goes through during the life cycle. The highest value is achieved in the product development process by adding value in each and every stage. Doing that requires each stage and synchronization between stages to be effective. VCA helps make it clear that an appropriate organizational structure and processes are required. These will contain the required functional departments to perform these activities and a proper communication approach to synchronize the activities of these functional units efficiently.

Cautions with Applying this Method

Despite the strengths of VCA, its usefulness is being challenged by the radical changes that information technologies have wrought. A growing school of management thought asserts that traditional value chains oriented around vertical linkages cannot constantly reinvent value at the speed required for successful strategy execution and meeting customer responsiveness demands.

Traditional VCA was developed to help you understand physical assets and flows. It may not be as appropriate to employ for competition based on intellectual assets and services. That being said, newer conceptual developments are happening in the broader scholarship. They increasingly allow for functional modification of the traditional VCA for emerging modes of competitiveness, including value net analysis, value grid analysis, value migration, value constellation analysis, value stream mapping, value shop analysis, and service value chains.

Managing value chains in an information communication and technology environment requires the inclusion of economic realities that are not explicitly addressed by original versions of the VCA model (like Porter’s). VCA treats information as a supporting element in the company’s strategy. At best, it is only part of a secondary activity. Recent models such as the virtual value chain and value web management treat information as a separate and distinct value-creating factor that must be managed separately but together with the enduring physical value chain.

VCA also has been criticized for being too simplistic because many of its qualitative prescriptions are difficult to implement. The most prominent shortcoming is that they require significant amounts of resources. Effective VCA requires a large investment in benchmarking, customer and stakeholder research, competitive analysis, and industry structure analysis, often using data that is not freely or easily available. Conducting VCA might be straightforward in theory, but it is relatively difficult and time-consuming to apply for maximum and relevant effect. This is a key reason why many companies do not choose to exploit it in their ongoing analysis activities.



Furthermore, most of a company’s internal accounting data is incompatible with the analytical dimensions of VCA for several reasons. Traditional management accounting systems rarely, if ever, do the following:

• Collect data related to value-creating activities. Instead, they collect data related to product/service and period costs.

• Collect period costs by product or service, making it difficult to accurately assign overhead costs to value-creating processes.

• Collect data on cost drivers. Departmental budgets are rarely an accurate source for determining the actual cost of value-creating activities.

• Enable transfer prices and arbitrary cost allocation of traditional management accounting systems to appropriately encompass the synergies created by horizontal links in the company’s value chain or the vertical links in the industry’s value system.

Applying the Method

Conducting a successful VCA requires judgment, attention to detail, competitive knowledge, and quantitative analysis. Understanding the company’s industry structure and, more importantly, aligning this knowledge with the company’s capabilities, are intrinsic to crafting successful strategies.

The VCA process begins with an internal analysis of the company’s value chain, followed by an external competitive analysis of the industry value system. It concludes by integrating these two analyses to identify and create a strategy that can potentially sustain competitive advantage.

Step 1: Define the Company’s Strategic Business UnitsThe first level of review draws boundaries around the business’s various segments. This is necessary because the different segments of the business will have different sources of competitive advantage that require different strategies.

Step 2: Identify the Company’s Critical Value-Creating ActivitiesFor companies that haven’t adopted ABA, Porter offers several distinctions that define value-creating activities. These companies are those that

• Have different economic structures• Contribute to a large or growing percentage of total costs• Contribute to or have a strong probability of contributing to product/service differentiation

Step 3: Conduct an Internal Cost AnalysisCompanies can achieve cost advantages and better margins by either reducing the cost of individual value chain (VC) activities or reconfiguring the VC. Reconfiguration means structural changes such as a new production process, new distribution channels, or a different sales approach such as direct-to-consumer approaches instead of owning retail outlets. An internal cost analysis is composed of the following steps:

1. Assign costs to each critical value-creating activity identified in Step 2



2. Find the cost drivers for each critical value-creating activity that is driven by more than one major cost category.

3. Diagnose the company’s current strategy for areas of potential low-cost advantage.

You should be able to estimate costs and margins for each of the activities in your chain like the above figure for a seafood processing company (Source: www.fao.org, accessed Jan. 23, 2014)

Step 4: Conduct an Internal Differentiation Value Advantage AnalysisDifferentiation advantages can arise from any segment of the value chain. For example, procurement of unique and scarcely available inputs that rivals cannot access can allow value-adding differentiation of the product to customers, as can effective distribution channels that provide customers with high levels of service quality. Similar to the internal cost analysis, the internal differentiation analysis starts with identifying the company’s value-creating activities and cost drivers.

Step 5: Map the Industry Profit Pool• Define the Parameters of the Industry Profit Pool• Estimate the Total Size of the Industry Profit Pool• Estimate the Distribution of the Profit Pool

Step 6: Vertical Linkage AnalysisThe opportunities to achieve cost and differentiation advantages within the company’s value chain were reviewed in Steps 1 through 4. Step 5 allowed you to determine whether the company is strategically positioned in the shallow or deep end of the industry’s profit pool. Vertical linkage analysis allows you to seek opportunities to exploit the most important sources of competitive advantage in the industry’s value system. You can combine your intimate knowledge of the company’s economic structure,


http://www.fao.org/


customer value, and external competitive analysis to determine how to reposition the company into the deep end of the industry profit pool - and keep it there

Step 7: IterationRepeat Steps 1 through 6 periodically by making VCA a central component of your company’s competitive intelligence and strategy development system. This helps you proactively manage evolutionary and revolutionary industry change. VCA should be completed at least annually and can show subtle shifts in rivals’ tactics or strategies that you may competitively exploit for optimal impact in most product, company, or industry spaces. This will help you determine how the primary and support activities can work together effectively and efficiently to help your organization achieve healthier margins and sustain competitive advantage.

Complementary Methods

• Benchmarking• Competitor Cash Flow Analysis• Competitive Profiling• Customer Value Analysis • Functional Capability and Resource Analysis• Profit Pools Analysis• SERVO Analysis• Strategic Cost Management• Supply Chain Management Analysis• SWOT Analysis

Additional Resources

See chapter 13 (pg. 221-245) on Value Analysis in the (2013) book Analysis without Paralysis: 12 Tools to Make Better Strategic Decisions, 2nd Ed., by Babette E. Bensoussan and Craig S. Fleisher, Upper Saddle River, NJ: FT Press.

Business and Competitive Analysis: Effective Application of New and Classic Methods by Craig S. Fleisher and Babette Bensoussan, 2007, Upper Saddle River, NJ: FT Press.

Strategic and Competitive Analysis: Methods and Techniques for Analyzing Business Competition by Craig S. Fleisher and Babette Bensoussan, 2003, Upper Saddle River, NJ: Pearson/Prentice Hall.

Competitive Advantage: Creating and Sustaining Superior Performance, by Michael E. Porter, 1985, New York, NY: The Free Press. The chapters in Part I are focused on VCA.

A Handbook for Value Chain Research by R. Kaplinsky and M. Morris. Paper produced for the IRDC. http://www.globalvaluechains.org/docs/VchNov01.pdf



customer value, and external competitive analysis to determine how to reposition the company into the deep end of the industry profit pool - and keep it there

Step 7: IterationRepeat Steps 1 through 6 periodically by making VCA a central component of your company’s competitive intelligence and strategy development system. This helps you proactively manage evolutionary and revolutionary industry change. VCA should be completed at least annually and can show subtle shifts in rivals’ tactics or strategies that you may competitively exploit for optimal impact in most product, company, or industry spaces. This will help you determine how the primary and support activities can work together effectively and efficiently to help your organization achieve healthier margins and sustain competitive advantage.

Complementary Methods

• Benchmarking• Competitor Cash Flow Analysis• Competitive Profiling• Customer Value Analysis • Functional Capability and Resource Analysis• Profit Pools Analysis• SERVO Analysis• Strategic Cost Management• Supply Chain Management Analysis• SWOT Analysis

Additional Resources

See chapter 13 (pg. 221-245) on Value Analysis in the (2013) book Analysis without Paralysis: 12 Tools to Make Better Strategic Decisions, 2nd Ed., by Babette E. Bensoussan and Craig S. Fleisher, Upper Saddle River, NJ: FT Press.

Business and Competitive Analysis: Effective Application of New and Classic Methods by Craig S. Fleisher and Babette Bensoussan, 2007, Upper Saddle River, NJ: FT Press.

Strategic and Competitive Analysis: Methods and Techniques for Analyzing Business Competition by Craig S. Fleisher and Babette Bensoussan, 2003, Upper Saddle River, NJ: Pearson/Prentice Hall.

Competitive Advantage: Creating and Sustaining Superior Performance, by Michael E. Porter, 1985, New York, NY: The Free Press. The chapters in Part I are focused on VCA.

A Handbook for Value Chain Research by R. Kaplinsky and M. Morris. Paper produced for the IRDC. http://www.globalvaluechains.org/docs/VchNov01.pdf


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Mtm11 white paper value chain analysis