Value Chain

I thought about putting together my own introduction to the value chain video and then I found these value chain videos from Professor Andrew Fearne which I thought were very well done. These focus on the industry value chain rather than the business value chain.

Who Is Andrew Fearne?

Andrew Fearne is a professor at the Norwich Business School.

The Videos

Value Chain Thinking

Episode 1: Value Chains

Episode 2: Business Benefits

Episode 3: Success Factors

Episode 4: Common Mistakes

Episode 5: Value Chain Analysis

Other Value Chain Videos

Value Chain Analysis is the big idea in Michael Porter’s classic strategy book Competitive Advantage.

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The Advantages Of Value Chain Analysis

1. A big advantage is that the value chain is a very flexible strategy tool for looking at your business, your competitors and the respective places in the industry’s value system.
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2. The value chain can be used to diagnose and create competitive advantages on both cost and differentiation. I’ve written about this in Using The Value Chain To Create Competitive Advantage.
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3. It helps you to understand the organisation issues involved with the promise of making customer value commitments and promises because it focuses attention on the activities needed to deliver the value proposition.
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4. Comparing your business model with your competitors using the value chain can give you a much deeper understanding of your strengths and weaknesses to be included in your SWOT analysis.
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5. The value chain is well known and has been a mainstay of strategy teaching in business schools for the last 20 to 25 years. The book, Competitive Advantage was published in 1985.
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6. It can be adapted for any type of business – manufacturing, retail or service, big or small.
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7. The value chain has developed into an extra model, the industry value chain or value system which lets you get a better understanding of the much broader competitive arena. If you’re interested in this aspect of the value chain, watch the Value Chain Videos for an easy-to-understand introduction.

The Disadvantages Of Value Chain Analysis

1. It’s very strengths of flexibility mean that it has to be adapted to a particular business situation and that can be a disadvantage since, to get the best from the value chain, it’s not “plug and play”.
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2. The format of the value chain laid out in Porter’s book Competitive Advantage, is heavily oriented to a manufacturing business and the language can be off-putting for other types of business.
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3. The scale and scope of a value chain analysis can be intimidating. It can take a lot of work to finish a full value chain analysis for your company and for your main competitors so that you can identify and understand the key differences and strategy drivers.
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4. Many people are familiar with the value chain but few are experts in its use.
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5. Michael Porter’s book is excellent but it is a tough read. It’s also dated in its examples which can make some ideas more difficult to relate to and understand how things fit together in the Internet age.
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6. The value chain idea has been adopted by supply chain and operations experts and therefore its strategic impact for understanding, analysing and creating competitive advantage has been reduced.
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7. Business information systems are often not structured in a way to make it easy to get information for value chain analysis.

A Partial Analysis Of The Value Chain

A full value chain analysis can make the strategy process long, time-consuming and complex.

I don’t believe it’s necessary in many cases.

Strategy is about finding insight to create competitive advantage and then taking the actions necessary to put the ideas into action.

It can be very effective to identify the business processes and the individual roles they can play – positive and negative – for implementing a particular strategy.

Using the Value Chain To Find Value Destroying Activities

Sometimes stopping a value destroying activity is more important than strengthen a value creating process. These happen because the use of individual goals, targets and incentives can lead to actions that harm the bigger business goals.

A great example is the buyer in a steel company who is targeted with getting the lowest cost when the business has an overall differentiation strategy of fast lead times and reliable due date supply to customers. Something has to give – it may be the service promise or  inventory levels are forced to rise and may create as many costs as the buyer hopes to save.

Using the Value Chain For Focused Improvement Of Processes

The most critical processes can then be broken down into value activities for more detailed analysis of what the business is trying to achieve and how it is currently operating. That opens the opportunity for focused process improvement on the areas of constraint which offer most leverage.

Yes the belt and braces approach of doing the full value chain analysis can be comforting because you know everything has been looked at, analysed and considered.

But often, resources and time aren’t available.

My view is that some value chain analysis is better than none. Focus on the important stuff that really matters.

The Value Chain And The Six Step Profit Formula

I use a Six Step Profit Formula to help keep strategic management grounded in what can help you to increase profits in the short and long term.

The value chain is useful in a number of steps. In particular, it has a role to play in helping you to develop your irresistible promise and making sure that you deliver it consistently. It also helps you to think through how you continue to get revenue and profit from the relationship.

What Do You Think Are the Advantages & Disadvantages of Value Chain Analysis?

I’d welcome comments based on your own experience or knowledge of the value chain.

What advantages or disadvantages do you think I have missed?

What should be emphasised more?

I encourage you to contribute to the debate on the value chain as a way to develop your own understanding on it and to help others.

Using the concept of the industry value chain analysis is an important part of gaining an appreciation for the wider competitive factors that can impact on your business.

Background To The Industry Value Chain Or Value System

The idea of the value chain was introduced in the classic strategy book Competitive Advantage by Michael Porter as a way to understand and develop competitive advantage.

While much of the book looks at the value chain within a business, Michael Porter stresses the importance of linkages between the business and its suppliers and customers which gives rise to the analysis of the industry value chain or what Michael Porter called the Value System.

For more details of the value chain within a business please see:

Using the Value Chain For Competitive Advantage

The Advantages & Disadvantages Of The Value Chain

Videos About The Value Chain

What is Industry Value Chain Analysis

A business takes some form of input and creates an output product or service that a customer is willing to pay for.

Most businesses therefore buy products from suppliers and sell to customers who then either sell the product as it is or use it to create another product or service to sell.

This creates a value chain (or a value system) of suppliers and customers in an industry.

For example, a cheese company buys milk from farmers, turns it into cheese and sells it to a distributor who then sells it to the supermarkets who sell it to the consumer. That’s an industry value chain as each step in the process creates an element of value that the customer is willing to pay for in the final price.

Value chains can also branch out into different distribution channels so staying with the cheese company example,as well as the supermarket route to the consumer, the distributor also sells to food processing companies who use the cheese to create ready-made meals to sell to the supermarkets.

The supermarkets sell to local restaurants who use the cheese in their menus and the local sandwich businesses that provide your lunch.

Each activity within the industry value chain has its own needs and preferences and plays some role in shaping the product and the value the ultimate consumers gets from the product. Each activity has its own cost dynamics and the way the activities link together can either add value or create unnecessary costs.

Industry value chain analysis allows you to look at the way the entire system works together to help you to find ways to create competitive advantage so your business earns higher profits.

The Industry Value Chain Analysis System

The diagram below shows five different activities within the industry value chain or value system.

The Industry Value Chain shows the alternative ways of competing, each with advantages and disadvantages

I’d like you to imagine that you are the business highlighted in yellow, a provider of the third activity in the value chain which links various independent suppliers.

You analyse the industry value chain and whilst there are many independents like you, you notice that there are some competitors that are set up differently.

• One competitor who is vertically integrated backwards i.e. they have a business that combines what you do with your immediate supplier. This gives them an advantage over control of the incoming supplies and means that supply priorities can be much clearer, However there is a balancing act for scale efficiencies since the two processes are linked.
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• Another competitor is part of a group which has three business units, the first deals with the first two stages of production, the second does what you do and the next stage and the third sells the product to the final consumer.
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• The final competitor in the industry value chain is a fully integrated business that does all five steps.

Industry Value Chain Analysis – A Look At What Is

Once you’ve sketched out the industry value chain or value system, you’ll have a broader view of how you fit into the market since you’ll see yourself as part of a value delivery system which competes with alternative value delivery systems.

You can start looking at the implications of each.

• What causes cost and value to accumulate within an activity?
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• How some value chains create advantage for those who use them and how you can respond or react?
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• How profit accumulates in particular sections of the industry value chain? The classic example is the portable computer industry where Intel and Microsoft have created strong strategic positions which capture a high proportion of the overall profits made in the industry value chain, leaving other component manufacturers, PC assemblers and PC distributors trailing.

Understanding what is currently happening in your industry can help you to look at

• Business definition issues – what activities in the industry value chain should you be doing? Should you vertically integrate backwards or forwards? Or should you focus on building up your core competences in a tightly defined area and establish a strategic control position, just like Intel and Microsoft?
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• How you can create competitive advantage and where it is futile to try because the business design of your competitors has major strengths and weaknesses?
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• Where your own business model is vulnerable to competitive attack and what you can do about it?

Industry Value Chain Analysis – A Look At What Might Be

The book Profit Patterns by Adrian Slywotzky and David Morrison makes it clear that industry value chains used to be stable over the long term but over the last twenty years there has been much more movement which creates profound impact on the businesses operating within them.

Unfortunately many businesses miss the changes that are happening around them until it is too late and they are trapped in a no profit zone and business system. This is a significant threat which should be identified and included in your SWOT Analysis.

They identify a number of profit patterns to look out for:

• Value Chain Convergence – competitors from previously distinct industries start to compete against each other as their products compete to meet the consumers’ underlying needs. As an example, think about how Skype and the other voice over the Internet providers have damaged traditional telephone service providers like British Telecom. Or how the development of smartphones impact on laptop PC providers and how touchpad products like the iPad make the dividing line between products much fuzzier. Slywotzky and Morrison identify three levels of convergence – supplier convergence, product convergence and complementor convergence.
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• Value Chain De-integration – businesses focused on one value activity have created strategic control positions that capture a high share of the profits created by the entire value chain – this is the Microsoft or Intel example.
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• Value Chain Squeeze – how growing strength of operators in the activities either side of a particular value in the industry chain can apply the buyer power and supplier power from Porter’s Five Forces to create a no profit zone.
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• Value Chain Strengthening The Weak Link – one activity in the industry value chain may be systematically destroying value for the entire chain through high costs and poor quality and service. Strengthening this weak link can put a business in a very powerful position to exert influence and capture profit from the entire chain.
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• Value Chain Reintegration – while disintegration can create value, so can reintegration. Apple was once a struggling business that was losing the PC operating system against Microsoft because of its refusal to let others use its operating system. Now look at it and the control it has over many stages in the industry value system, outsourcing when appropriate but keeping control over key elements including close links with consumers through the Apple stores.

Changes to the industry value chain are a little like the analogy of the boiled frog who doesn’t notice that the water is gradually getting hotter until it is too late, by which time it’s too sleepy to do anything.

The way to look out for industry value chain movements and what might be happening is through competitive analysis to keep track of changes each year. This way you can get an early warning of the patterns that might be developing in your industry and have the time to either decide to participate or to create defensive strategies.

Industry Value Chain Analysis – A Look At What Could Be

The third element of industry value chain analysis is to use it pro-actively to think about how you can configure it to your advantage over the long term.

You don’t have to wait for the profit patterns to happen based on the actions of competitors, if you see the opportunity you can start the process yourself.

Opportunities arise from:

• Deregulation of previously regulated activities
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• Changing customer needs and priorities
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• Technology changes

Your competitors, who may not use industry value chain analysis, might not notice what you are doing or might not realise the significance of your actions until you’ve established a long-lasting advantage.

Industry Value Chain Videos

I found these value chain videos from Professor Andrew Fearne which focus on the industry value chain or value system.

Have You Used Industry Value Chain Analysis?

Have you used industry value chain analysis and found it helpful to:

• Understand what is happening in your wider competitive space?
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• Identified potential threats early?
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• Identified opportunities?

Please leave a comment and share your experience or any tips you’ve found that makes doing the industry value chain analysis easier.

My thinking on strategy is heavily influenced by Michael Porter and his classic book Competitive Advantage introduced the concept of the value chain analysis.

The value chain is an original Porter concept although he built on the idea of the business system from strategy consultants McKinsey and its main purpose is to help you to find, create or develop competitive advantages.

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Types of Competitive Advantage

Michael Porter argues that there are only two types of competitive advantage:

• competitive advantage that comes from differentiation – providing some kind of unique value to particular customers
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• competitive advantage that comes from having the cost leadership position

While it would be nice to have both, under normal conditions, the two forms of competitive advantage are mutually exclusive and, if businesses fail to choose, they get stuck in the middle.

Michael Porter believes that these competitive advantages derive from the activities the business does which are:

• done better than competitors;
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• done differently than competitors;
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• that create unique benefits; or
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• done at a lower cost than competitors.

To understand the source of competitive advantage then you need to perform a value chain analysis which identifies the separate value activities.

The Formal Elements of Value Chain Analysis

Porter built his value chain analysis model on a manufacturing business – back in 1985 there were many more around in the United States.

He split the value chain into two parts:

• Primary value activities
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• Support value activities

Primary value activities included:

• Inbound logistics
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• Operations
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• Outbound logistics
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• Marketing & sales
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• Customer service

Support value activities include:

• Procurement
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• Technology
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• Human resources
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• Firm infrastructure

This is a very general, helicopter view of a business and when you’re carrying out your value chain analysis you are supposed to go much more specific and detailed for your business.

You keep analysing activities which give a differentiation advantage (or have the potential to do so)  or disadvantage and which have a cost advantage or disadvantage.

The idea of value chain analysis is that you understand how your business compares with competitors at a detailed level. You can go into a lot of detail for your own business but you’ll be surprised at what you can learn about your competitors by talking to ex-employees (who may already work for you), suppliers, customers and being the customer yourself.

The value chain has been criticised as too prescriptive because the value chain elements don’t fit all types of businesses. This is missing the point entirely.

You don’t have to follow Michael Porter’s categorisation – and I suspect that he’d be astonished if you did – but if you want to understand the sources of your competitive advantages in terms of differentiation and cost, you do need to perform a value chain analysis which fits your business/industry.

It does take some thought and effort but that can be more of a reason to do it. Your lazy, superficial competitors either won’t understand the value chain or will look at what’s involved and think “That’s too difficult”.

Adapting Value Chain Analysis For Differentiation Or Cost Leadership

In his book Competitive Advantage (a must-read for any strategy professional), there are long chapters for how you can use value chain analysis to create cost or differentiation competitive advantages.

You’ll have guessed from the title of my blog, I’m not a huge fan of the cost leadership. That’s because I think there’s always someone who can come along and product whatever [product or service you sell a bit cheaper. For a cost leadership strategy to work, you have to have a significant cost differential which competitors recognise. Otherwise, you’re caught in a commodity trap selling an undifferentiated product at lower and lower prices.

But you can’t ignore costs if you follow the differentiation advantage path.

If your main differentiators are in marketing and customer service then you must keep a focus on costs in the logistics and operations activities and all the support activities. Your differentiation advantage only excuses you incurring extra costs in the activities which create a competitive advantage and only then if the advantage outweighs the extra costs.

How To Do Value Chain Analysis: Identify Your Value Activities

Use Michael Porter’s model if you find it helpful but otherwise create your own high level process map for your business which can also be used for your competitors.

Then drill down to identify the individual activities which create a differentiation advantage or which incur significant costs. Group minor activities together in categories like “other marketing activities”.

It helps if there are several people working on the value chain analysis. Functional specialists who know what’s happening and others who can provide an outsider’s perspective and ask the “dumb questions” which can challenge conventional wisdom and provide significant insight.

How To Do Value Chain Analysis: Allocate Costs To The Value Chain Activities

You can spend a lot of time trying to allocate costs precisely but it’s a false exercise.

It’s much better to be approximately right than precisely wrong.

Activities will incur some costs directly while other costs need to be apportioned based on various assumptions. Don’t confuse the two since you can draw very different conclusions if you change the underlying assumptions.

How To Do Value Chain Analysis: Identify Sources Of Differentiation Advantage

Differentiation comes from:

• the way individual activities are performed
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• the way related activities link together
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• the way the entire value chain is structured

I recommend you work both ways:

From your current or desired key success factors and differentiation factors through to your value activities in a deliberate challenge to see what you can do to support your differentiation advantages.

Then from your individual activities back out to your customers by asking “is there anything in the way we do this activity (or could do the activity) which creates special value for the customer?”

Differentiation & Your Customer’s Value Chain

You can learn a lot from applying value chain analysis to your own business and thinking through how all the parts fit together to support your customer value proposition.

You may get even more insights by looking at the value chain of your typical customer (or different groups of customers) and identifying ways that you can add value or reduce costs to their business by better understanding:

• What your customers are trying to do.
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• How they operate.
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• Their problems and frustrations.

Having a better understanding of your market and the customers who make it up is potentially a big competitive advantage since it lets you develop better products and to respond to changing needs faster than your competitors.

Is The Value Chain Analysis Only For Big Businesses?

No I don’t think so.

Small businesses are often simpler to understand so it means a value chain analysis can be put together quicker.

There’s no getting away from the idea that competitive advantages and disadvantages flow from the activities you do in your business but you can only understand them and how they link together by doing value chain analysis.

The Value Chain And The Six Step Profit Formula

I use a Six Step Profit Formula to help keep strategic management grounded in what can help you to increase profits in the short and long term.

The value chain is useful in a number of steps. In particular, it has a role to play in helping you to develop your irresistible promise and making sure that you deliver it consistently. It also helps you to think through how you continue to get revenue and profit from the relationship.

The Value Chain Is A Strategic Planning Model

The Value Chain is one of the frameworks included in my Strategic Planning Models guide.

Click the link to fined out what other models could help you to develop a winning business strategy.

What Do You Think About Value Chain Analysis?

Do you find Michael Porter’s ideas for value chain analysis a useful technique for creating competitive advantage, analysing the advantages of competitors and spotting opportunities for advantage?

I’d like to know what you think so please leave a comment.

In particular, do you believe that value chain analysis is a suitable technique for SMEs and businesses that don’t have strategic planning specialists.