Entering a new era of innovation, businesses are competing for unbeatable prices, fine products, successful marketing strategies and customer loyalty. One of the most valuable tools, the value chain analysis, allows businesses to gain an advantage over their competition.
According to Smartsheet, a value chain analysis helps you recognize ways you can reduce cost, optimize effort, eliminate waste and increase profitability. A business begins by identifying each part of its production process, noting steps that can be eliminated and other possible improvements.
In doing so, businesses can determine where the best value lies with customers, and expand or improve said value, resulting in either cost savings or enhanced production. At the end of the process, customers can enjoy high-quality products at lower costs.
What is a value chain?
A value chain is the full range of activities – including design, production, marketing and distribution – businesses conduct to bring a product or service from conception to delivery. For companies that produce goods, the value chain starts with the raw materials used to make their products, and consists of everything added before the product is sold to consumers.
Value chain management is the process of organizing these activities in order to properly analyze them. The goal is to establish communication between the leaders of each stage to ensure the product is placed in the customers' hands as seamlessly as possible.
Porter's value chain
Harvard Business School's Michael E. Porter was the first to introduce the concept of a value chain. Porter, who also developed the Five Forces Model to show businesses where they rank in competition in the current marketplace, discussed the value chain concept in his book "Competitive Advantage: Creating and Sustaining Superior Performance" (Free Press, 1998).
"Competitive advantage cannot be understood by looking at a firm as a whole," Porter wrote. "It stems from the many discrete activities a firm performs in designing, producing, marketing, delivering and supporting its product. Each of these activities can contribute to a firm's relative cost position and create a basis for differentiation."
In his book, Porter splits a business's activities into two categories: primary and support.
Primary activities include the following:
- Inbound logistics are the receiving, storing and distributing of raw materials used in the production process.
- Operations is the stage at which the raw materials are turned into the final product.
- Outbound logistics is the distribution of the final product to consumers.
- Marketing and sales involves advertising, promotions, sales-force organization, distribution channels, pricing and managing the final product to ensure it is targeted to the appropriate consumer groups.
- Service refers to the activities needed to maintain the product's performance after it has been produced, and includes things like installation, training, maintenance, repair, warranty and after-sale services.
The support activities help the primary functions and comprise the following:
- Procurement is how the raw materials for the product are obtained.
- Technology development can be used in the research and development stage, in how new products are developed and designed, and in process automation.
- Human resource management includes the activities involved in hiring and retaining the proper employees to help design, build and market the product.
- Firm infrastructure refers to an organization's structure and its management, planning, accounting, finance, and quality-control mechanisms.
Conducting the analysis
According to an article on Strategic Management Insight, there are two different approaches to the value chain analysis: cost and differentiation advantage.
Cost advantage: After identifying the primary and support activities, businesses should identify the cost drivers for each activity. For a more labor-intensive activity, cost drivers could include how fast work is completed, work hours, wage rates, etc. Businesses should then identify links between activities, knowing that if costs are reduced in one area, they can be reduced in another. Businesses can then identify opportunities to reduce costs.
Differentiation advantage: Identifying the activities that create the most value to customers is the priority. These can include using relative marketing strategies, knowing about products and systems, answering phones faster, and meeting customer expectations. The next step is evaluating these strategies in order to improve the value. Focusing on customer service, increasing options to customize products or services, offering incentives, and adding product features are some of the ways to improve activity value. Lastly, businesses should identify differentiation that can be maintained and adds the most value.
Free templates are available online to help businesses determine and analyze their value chains.
Goals and outcomes
Ideally, value chain analysis will help identify areas that can be optimized for maximum efficiency and profitability. It is important, along with the mechanics of it all, to keep customers feeling confident and secure enough to remain loyal to the business. By analyzing and evaluating product quality and effectiveness of services, along with cost, a business can find and implement strategies to improve.
Additional reporting by Katherine Arline.
The business management concept of the value chain was introduced and described by Michael Porter in his popular book "Competitive Advantage: Creating and Sustaining Superior Performance" in 1985. A value chain is a series of activities or processes that aims at creating and adding value to an article (product) at every step during the production process.
Businesses aim at enhancing their margins and thus work to change input into an output which is of a greater value (the difference between the two being the company’s profit margin). The logic behind it is simple: The more value a company creates, the more profitable it is. The enhanced value is passed on to the customers and thus further helps in consolidating a company's competitive edge.
Value-chain business activities are divided into primary activities and secondary activities. The primary activities are directly related to the creation of a good or service, while the support activities help in enhancing the efficiency and work to obtain a competitive advantage among peers. (For related reading, see Industry Handbook: Porter's 5 Forces Analysis)
Let’s take the example of Starbucks (NASDAQ: SBUX) to understand this better. The Starbucks journey began with a single store in Seattle in the year 1971 to become one of the most recognized brands in the world. Starbucks mission is, per its website, “to inspire and nurture the human spirit – one person, one cup and one neighborhood at a time.”
The inbound logistics for Starbucks refer to company-appointed coffee buyers selecting the finest quality coffee beans from producers in Latin America, Africa and Asia. In the case of Starbucks, the green or unroasted beans are procured directly from the farms by the Starbucks buyers. These are transported to the storage sites, after which the beans are roasted and packaged. They are then sent to distribution centers, a few of which are company owned and some of which are operated by other logistic companies. The company does not outsource its procurement, ensuring high quality standards right from the point of selection of coffee beans.
Starbucks operates in 65 countries, either in the form of direct company-owned stores or licensees. Starbucks has more than 21,000 stores internationally, including Starbucks Coffee, Teavana, Seattle’s Best Coffee and Evolution Fresh retail locations. According to its annual report, the company generated 79% of its total net revenue during fiscal year 2017 from its company operated stores while the licensed stores accounted for 10.5%.
There is very little or no presence of intermediaries in product selling. The majority of the products are sold in their own or in licensed stores only. As a new venture, the company has launched a range of single-origin coffees, which will be sold through some leading retailers in the U.S.; these are Guatemala Laguna de Ayarza, Rwanda Rift Valley and Timor Mount Ramelau.
Starbucks invests more in superior quality products and high level of customer service than in aggressive marketing. However, need-based marketing activities are carried out by the company during new products launches in the form of sampling in areas around the stores.
Starbucks aims at building customer loyalty through its stores' customer service. The retail objective of Starbucks is, as it says in its annual report, “to be the leading retailer and brand of coffee in each of our target markets by selling the finest quality coffee and related products, and by providing each customer a unique Starbucks Experience.”
This includes departments like management, finance, legal, etc., which are required to keep the company’s stores operational. Starbucks' well-designed and pleasing stores are complemented with good customer service provided by the dedicated team of employees in green aprons.
Human Resource Management
The committed workforce is considered a key attribute in the company’s success and growth over the years. Starbucks employees are motivated through generous benefits and incentives. The company is known for taking care of its workforce, a key reason for a low turnover of employees, which indicates great human resource management. There are many training programs conducted for employees in a setting of a work culture which keeps its staff motivated and efficient.
Starbucks is very well-known for use of technology, not only for coffee related processes (to ensure consistency in taste and quality along with cost savings) but to connect to its customers. Many customers use Starbucks stores as makeshift office or meeting place because of the free and unlimited WiFi. Back in 2008, the company also launched mystarbucksidea.force.com as a platform where customers can ask questions, give suggestions and openly express opinions and share experiences. The company has implemented some of the suggestions given via this forum. Starbucks also uses Apple’s iBeacon system wherein customers can order their drink through the Starbucks phone app and get a notification of its readiness when they walk in the store.
The Bottom Line
The concept of value chain helps to understand and segregate the useful (which help in gaining a completive edge) and wasteful activities (which hamper market lead) accompanying each step during the product development process. It also explains that if value is added during each step, the overall value of the product gets enhanced thus helping in achieving greater profit margins.