Value Chain Analysis

Presented to
Prof. Sitangshu Khatua
By
Manish Jaiswal (JSB-01-007)

Sohong Chakravorty(JSB-01-012)
Sanchita Debnath (JSB-01-011)

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 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 organization’s sustainable
competitive advantage in the business arena of the 21st Century. All
organizations consist of activities that link together to develop the value
of the business, and together these activities form the organization’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
organization for nearly two decades. The aim of the value chain
framework is to maximize value creation while minimizing 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
organization, and have the potential of a sustainable competitive
advantage for a company. Therein, competitive advantage of an
organization 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”. 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 organization’s 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 effectiveness and efficiency of the firm, such as human resource
management. The primary and secondary activities of the firm are
discussed in detail below.

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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

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.

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• 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

Fig1: 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,

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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).

How to write a Good Value Chain Analysis

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
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 analyze each activity in the business with some depth
(Pearson, 1999). The value chain should be analyzed with the core
competence of the company at its very heart (Macmillan et al, 2003).
The value chain framework is a handy tool for analyzing 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,

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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 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 organizations 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. Therefore, it is important to have an in-depth understanding of
the company’s strengths and weaknesses in each activity in terms of cost
and differentiation factors.
The strategy of Wal-Mart worked when the company improved its
business through innovative practices in activities such as purchasing,
logistics, and information management, which resulted in the value
offering of “everyday low prices” (Magretta, 2002). It is important to
note that refining business models on a constant basis is as critical to the

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success of the company as its business strategy. Notably, both the
strategy and business model of an organization are crucial for the
robustness of the overall value chain.

For example, 7-Eleven had been vertically integrated, controlling most

activities in the value chain by itself. The company has now outsourced
many parts of its business including functions like HR, IT management,
finance, logistics, distribution, product development, and packaging.
According to Gottfredson et al (2005), the value chain decisions of
companies will increasingly shape their overall organisational structure.
Moreover, the value chain decisions will play a role in determining the
type of management skills that companies may need to develop or
acquire to survive in fiercely competitive business markets.
The Apple podcasting value chain is comprised of nine steps that
essentially move from raw content to the listener. All the steps of the
value chain include content, advertising, production, publishing,
hosting/bandwidth, promotion, searching, catching, and listening. It is
important to note that each step in the value chain adds value to the
podcast in distinctive ways, has its own sets of challenges and
opportunities.
It is important to note that the nature of value chain activities differs
greatly in accordance with the types of companies and industries. For
companies with complex systems like IBM, Accenture and Cisco etc., it is
not possible for one member of the value chain to provide all the
products and services from start to finish. The marketing function in such
companies focuses on aligning with key partners and allies that must
collaborate with each other. For example, installing SAP's ERP system
requires direct involvement from companies like HP, Oracle, and
Accenture, along with indirect involvement of companies like EMC, Cisco,
and Microsoft, and collaboration between many departments within the
company. The market assets contrast starkly between the companies
with complex systems and those that are driven by volume operations.
For example, in case of Apple’s leading products like Macintosh and the
iPod, the entire offer is inside a package, and the entire value chain is
preassembled. The change of supplier for the Macintosh from IBM, to
Intel, improved the system performance while retaining the value in
terms of price to the consumer. The only variable to manage in Apple’s
case is the consumers’ preferences. The role of creating differentiation
through unique quality features, along with promotion in order to create
brand awareness, image and eventually brand equity becomes imperative
for volume operations driven companies like Apple (Moore, 2005).
It is imperative to note that the value chains of companies have

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undergone many changes over the last two decades, due to the rapidly
changing business environment. Information technology and the Internet
have played a fundamental role in transforming certain parts and the
inter linkages between parts of the value chains of companies today.
Moreover HRM is increasingly becoming a vital asset in the value chain
that contributes to competitive advantage. Strategic alliances are also

becoming an integral part of the value chains. For example, IBM once
enjoyed backward vertical integration into the disk drive industry and
forward vertical integration into the consulting services and computer
software industries (Hill et al, 2007). According to the changing business
environment, IBM had more than 400 strategic alliances as of 2003
(Thompson et al, 2003). Herein, the value chain analysis is useful in
providing a framework to examine the advantages that partners can give
to each other (Pathania-Jain, 2001). It is important to note the source of
competitive advantage of a company for the value chain analysis. The
competitive advantage for IBM, for example, lies in depth, breadth and
the geographic spread of its global operations (Rai, 2006) and the loyalty
that the big blue enjoys from its clientele.
Lastly, analysts should look for the managerial implications that the new
era of capability outsourcing may bring. The value chain decisions of
companies will increasingly shape their organizational structure.
Furthermore these decisions will determine the types of managerial skills
that companies may need to develop to survive in an increasingly
competitive business environment.

Where to find information for Value Chain Analysis

Analysts can explore various sources to find information necessary for
conducting the value chain analysis. Up to three years of annual reports
of the company can be analyzed to see how the costing of the activities
are changing over the period and whether they are in unison with the
competitive strategy of the firm. These annual reports of the company
can be compared to the annual reports of the key competitors in order to
see how competitive strategies differ between the companies, along with
finding the difference in the contribution of activities to the company’s
profitability.
In order to gain knowledge about the core competence of the company,
analysts can look at the company and competitor websites. SWOT
analysis of the companies done by companies like Data-monitor etc. can
help the analyst to understand the key strengths and weaknesses of the
company and how the firm differs from its competitors. Furthermore,
journal articles, trade publications and magazines are useful sources of
information to identify how value is created in the particular industry in
which the company operates and which activities play a key role in the

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generation of that value.

Limitations of Value Chain Analysis

One of the limitations of the value chain model is that it describes an

industrial organization which essentially buys raw materials and
transforms these into physical products. Notably, at the time when the
model was introduced (Porter, 1985), service industries in the western
countries employed lesser workforce compared to today’s statistics of
the same (www.wikipedia.org). Academics and practitioners alike have
critiqued the model and its applicability in the context of service
organizations. Partnerships, alliances and collaboration along with
differentiation and low costs are common drivers of value today.
The limitations of the model include the fact that ‘value’ for the final
customer is the value only in its theoretical context (Svensson, 2003),
and not practical terms. The real value of the product is assessed when
the product reaches the final customer, and any assessment of that value
before that moment is only something that is true in theory. Despite this
limitation, analysts can effectively use the value chain model to
determine the value to the final customers in a theoretical way. Use of
other planning tools and techniques like Porter’s generic strategies,
analysis of critical success factors etc. is recommended in conjunction
with the value chain framework for a more comprehensive analysis of a
company’s strategy and planning.

Conclusion

The value chain framework has been used as a powerful analysis tool for
organizational strategic planning for nearly two decades now. The value
chain framework shows that the value chain of a company may be useful
in identifying and understanding crucial aspects to achieve competitive
strengths and core competencies in the marketplace. The model also
reveals how the value chain activities are tied together to ultimately
create value for the consumer. The five primary activities and four
support activities form an interdependent system that is connected by
linkages. Analysts conducting the value chain analysis should break down

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the key activities of the company according to the activities entailed in
the framework, and assess the potential for adding value through the
means of cost advantage or differentiation. Finally, it is important to
determine strategies that focus on those activities that would enable the
company to attain sustainable competitive advantage.

It is important to analyze the value chain of a company with the core

competence at its very heart. The nature of value chain activities differs

greatly in accordance with the types of companies and industries. The

value chains of companies have undergone many changes in the last two
decades due to advancements in technology facilitating change at a very
rapid pace in the business environment. Outsourcing will cause major
changes in organizations and their value chains, with significant
managerial implications.
Sources for finding information on value chain analysis include three
years annual reports of the particular company and its key competitors,
company websites, journal articles, and other reputed trade magazines
etc. Use of other planning tools and techniques like Porter’s generic
strategies, analysis of critical success factors etc. is suggested in
conjunction with the value chain framework for a more comprehensive
analysis of a company’s strategic planning.

References

www.wikipedia.com

www.marketing.com

www.management.com

www.scribd.com

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