Michael Porter introduced the Value Chain Analysis in 1985 to address criticism that his Five Forces framework did not provide a method for connecting internal capabilities and opportunities in the competitive landscape. This framework focused on industry attractiveness as a factor influencing the profit potential of all companies in that industry. However, different companies in the same industry can have varying levels of performance, which can be attributed to their involvement in a successful strategic group or their specific competitive advantages. The Value Chain Analysis helps identify a company’s core competencies and distinguish the activities that drive competitive advantage. The cost structure of an organization can be broken down into separate processes or functions, assuming that the cost drivers for each activity behave differently. When an organization’s value chain, used to develop a product, can add value without additional costs, a competitive advantage is achieved. Figure 1 below illustrates Porter’s distinction between two types of activities in the value chain: primary activities and support activities.
These activities are related to production, transformation, delivery, and sales and are divided into four main categories:
Inbound Logistics: includes receiving, storing, and providing the necessary inputs for product delivery. This category involves activities like materials handling, warehousing, inventory control, and transportation.
Operations: involves packaging, maintaining, and transforming the inputs received through inbound logistics into the final product. This category includes machine operation, assembly, packaging, testing, and maintenance.
Outbound Logistics: encompasses activities such as picking, packing, storing, and delivering the finished product to the end customers. It includes order processing, warehousing, transportation, and distribution.
Marketing and Sales encompass various activities related to advertising, promotion, distribution channel management, marketing, and sales of products. The primary focus is on understanding and meeting customer needs to enhance the development of future products. Marketing and Sales involve advertising, promotion, selling, pricing, and channel management.
Service activities involve measures to maintain and enhance the value of the product for customers. These include installation, repair, training, and post-delivery support services. Service activities encompass installation, servicing, and spare part management.
Various support activities are also part of the overall process.
These activities support the primary activities and include human resource management, procurement, technology development, and organizational infrastructure. Procurement includes activities involved in purchasing raw materials, supplies, and fixed assets (equipment, machinery) and transmitting them across the value chain. It also involves purchasing raw materials, lease properties, and supplier contract negotiations. Technology Development includes activities including research & development, design, processing, and servicing of the product manufacturing process and the product itself. This also involves IT, product, and process development.
Paraphrased and unified text:
Human Resource Management comprises activities such as recruiting, training, developing, empowering, and rewarding employees. This includes recruitment, education, promotion, and reward systems.
Organizational Infrastructure encompasses activities related to finance, accounting, planning, legal matters, governmental affairs, quality management, and general management. This includes general management, planning, finance, legal, and investor relations.
Efficient use of support activities can help achieve differentiation and lower production costs. For example, human resource management should ensure that staff is properly trained, motivated, and rewarded for value creation. Organizational infrastructure activities should support the value chain and facilitate business strategy implementation by identifying internal and external opportunities and threats.
Technology development activities can bring product differentiation by improving the development process. Lastly, cost-effective procurement activities that focus on finding reliable suppliers with high-quality goods can significantly reduce costs and add more value.
By breaking down an organization into key processes or functions, Porter was able to connect traditional accounting to strategic capabilities using value as a central concept.The text focuses on how a firm can effectively position itself against competitors based on its cost structure and the value chain. It mentions that the composition of the value chain allows the firm to compete on price and also differentiate its products to cater to specific customer segments.
Achieving Competitive Advantage with the Value Chain
The value chain is instrumental in enabling organizations to understand where value is generated during each of their activities and how to align those value-adding activities with the company’s strategy and customer needs. This series of activities, which forms a unique and integrated sequence for creating value, is challenging for competitors to replicate. Consequently, it establishes and sustains a competitive advantage for the organization. A notable example is The Warehouse Group Limited, the largest retail store in New Zealand. Through its effective execution and upkeep of valuable activities such as an advanced purchasing function, a state-of-the-art distribution center in Auckland, cross-functional integration, technology investments, exceptional people management, and strategic retail site identification and control, it has successfully achieved a sustained competitive advantage over its competitors (Briscoes, Farmers, and Kmart).
The benefits of value chain analysis are numerous and versatile. Firstly, it is a highly flexible strategy tool that allows businesses to assess their own operations, as well as those of their competitors, within the context of the industry’s value system. This analysis can be used to create competitive advantages in terms of cost and differentiation, as elaborated in my article on Using The Value Chain To Create Competitive Advantage.
Furthermore, value chain analysis facilitates a deeper understanding of the organizational issues related to delivering value commitments and promises to customers. It directs attention towards the activities necessary for fulfilling the value proposition.
In addition to its diagnostic capabilities, comparing one’s business model with that of competitors using the value chain can provide valuable insights for a comprehensive SWOT analysis, uncovering both strengths and weaknesses.
The value chain concept is widely recognized and has been an integral part of business school strategy education for the past two to three decades. Its roots trace back to the publication Competitive Advantage in 1985.
Moreover, this approach can be applied across various industries and business types, be it manufacturing, retail or service-oriented, irrespective of the scale.
Over time, the value chain has evolved into an extended model known as the industry value chain or value system. This expanded perspective enables a more comprehensive understanding of the broader competitive landscape. If interested in delving deeper into this aspect, I recommend watching the Value Chain Videos for an accessible introduction.
The drawbacks of value chain analysis include:
1. Its flexibility can be a disadvantage as it needs to be adapted to fit a specific business situation, rather than being a “plug and play” solution.
2. The value chain format outlined in Porter’s book Competitive Advantage is heavily focused on manufacturing businesses, which may not be applicable to other types of businesses.
3. Conducting a full value chain analysis for your company and competitors can be time-consuming and challenging, considering the scale and scope involved.
4. While many people are familiar with the value chain concept, only a few are experts in its application.
5. Michael Porter’s book on the topic is difficult to read and contains outdated examples that may be harder to relate to in the internet age.
6. The adoption of the value chain concept by supply chain and operations experts has diminished its strategic impact for understanding and creating competitive advantage.
7. Business information systems often lack the necessary structure to easily gather information for value chain analysis.
Pros: Value Chain Analysis offers a universal structure for analyzing both cost behavior and current and potential sources of differentiation.
Porter highlighted the significance of organizing functions into activities for the production, marketing, delivery, and support of products. He also emphasized the importance of considering relationships between these activities and connecting the value chain to comprehend an organization’s competitive position.
The value chain illustrates that an organization is complex and that its underlying activities must be examined to grasp its overall competitive standing. The organization’s strengths and weaknesses can only be determined in comparison to its direct competitors. Competitive advantage arises from a coordinated series of decisions concerning these pivotal activities.
The Value Chain model can serve as both a quantitative analysis and a qualitative assessment tool.
Porter’s Value Chain Analysis was an attempt to address the constraints of portfolio planning in multidivisional organizations. The Strategic Business Units approach suggested that businesses within a conglomerate should operate autonomously, with headquarters primarily responsible for budgetary decisions based on the business unit’s overall portfolio position. To promote a holistic perspective, Porter utilized the Value Chain Analysis to identify shared activities or synergies between Strategic Business Units.
Cons:
The quantitative analysis is time consuming as it often involves recalibrating the accounting system in order to allocate costs to individual activities.
Porter offered qualitative guidance for a quantitative exercise, starting with the identification of relevant activities that generate competitive advantages and have a significant impact on the organization’s cost base.
The Value Chain Analysis, when coupled with a customer segmentation analysis, allows for the integration of both internal and external perspectives. The firm can only gain a competitive advantage from a feature or product if customers are willing to pay for it. It is essential to analyze customer value chains to identify where value is generated.
The Value Chain is a tool used to assess a company’s competitive position compared to its rivals. It operates under the assumption that competition has a significant impact on profitability. However, this analysis does not consider other factors such as customer bonding in Alexander Hax’s delta model.
The Value Chain Analysis was originally designed to analyze physical assets in product-focused environments. However, it has since been modified by other authors to also consider intangible assets and service organizations. The Expert Group is responsible for answering questions related to different units of the company’s value, assigning scores ranging from 1 (representing no correspondence with the actual situation) to 5 (indicating full compliance). It is important to be extremely honest when answering these questions, taking into account the depreciation of the company’s own capabilities and exaggerating the competitors’ features. The collected results are then used to create a visual representation of the value chain, allowing us to assess the company’s current situation, identify areas with potential for growth, identify inefficient capital usage, and determine the actions that shape the company’s competitive edge and advantages. This graphical representation, along with the expert assessments, enables inexperienced Russian entrepreneurs and managers to identify their own competitive advantage and establish a successful and competitive enterprise.
