The term was coined in 1985 by Michael E. Porter, a Harvard Business School professor. His bookCompetitive Advantage introduced the basic value chain concept, outlining how businesses can identify primary and supporting activities to create value for their customers.
Porter’s value chain argument was that if the value a company offered its customers outweighed the cost of producing it, the result would be a bigger profit. Here’s an example of that calculation:
Value Created – Cost of Creating that Value = Profit Margin
What is value chain analysis?
Value chain analysis is the process of evaluating the activities in your company’s value chain. The goal is to review your processes and practices to find the following information:
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There are two different types of value chain analysis: cost advantage and differentiation. Let’s look at these in more detail.
Cost advantage. This approach is about competing on cost and involves cutting production costs and streamlining processes to increase profitability. For example, if your company develops apps, you can gain cost advantage by cutting contracting costs.
Differentiation. This involves adding value by offering a unique or high-quality product or service that sets you apart from your competition. For example, offering added features or superior customer service.
Which of these methods you choose to use depends on what you’re trying to achieve. If you want to boost your income, cost advantage is a good place to start. If you want to become the market leader, competitive differentiation is your best bet.
You can also combine the two methods to focus on gaining a competitive advantage while also cutting costs to increase your profits.
So, does competitive strategy affect value chain structure? The short answer is not really. Regardless of your preferred competitive strategy, the logic behind each method remains the same: the more value a company creates, the more profit it can make.
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What are the two categories of value chain activities?
A primary activity is anything that directly impacts the input, output or distribution of products or services. These business activities – which are also the primary activities of value chains – include:
Inbound/outbound logistics: Any activity involved in gaining resources or distributing the product, including receiving, storing and distributing products, goods and services. This activity takes into account practical processes, like storage and warehousing, deliveries, stock and transport needs and costs.
Operations: Anything that falls under the banner of producing the product, including machinery costs, product assembly and packaging.
Service: From customer support to your finance team, service covers anything that’s required to maintain quality control and quality assurance and support the customer during and after a sale. This can include things like warranties, installation, repairs or training.
A supporting activity takes the following into account.
Research and development/technology development: Any budget that’s been allocated to innovative activities such as developing and enhancing new and existing products and services.
Procurement: How any materials that allow a company to undertake its primary activities are sourced, such as raw materials, office supplies and machinery.
Human resource management: All processes and systems relating to managing the people in your organization, such as recruiting, training and retention.
Infrastructure: Your infrastructure is the operational aspect of your business. For example, company departments like finance, planning, IT and legal.
Combining the primary and supporting activities gives you a well-rounded approach to value chain analysis. You’ll review every part of your value chain framework (not just the key areas) which helps you accurately review your processes. As a result, you can make informed decisions about how to improve them.
How can value chain analysis help your business?
Take a look at some of the benefits you’ll have when performing a value chain analysis of your business.
Increased profits. Value chain analysis forces you to look at your processes with profit in mind. This gives you the clarity you need to increase customer value and cut costs – both of which can help you increase your profit margin.
A competitive advantage. After conducting a value chain analysis, you’ll be able to compare your operations, products and services with your competitors. It’s at this stage you can pinpoint how to get a competitive advantage and take the necessary steps to become the market leader.
New customers. Gaining a competitive advantage over rival businesses can help you entice new customers. Consumers will choose you over your competitors because of the value you provide.
Improved efficiency. When analyzing your value chain, you’ll break down your company logistics, operations and firm infrastructure. As a result, you’ll identify ways to streamline processes and improve efficiency.
A more effective sales team. Use value chain analysis to review how successful your reps are at attracting and qualifying leads and eventually closing deals. If there’s room for improvement, you can put new measures into place. The more effective each rep on your team is, the better your team will perform as a whole. And if your reps become faster and more effective at moving customer’s through the buying journey, you’ll pocket more revenue.
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Five steps to perform value chain analysis
Take a look at these simple steps to perform a value chain analysis in your business.
Step 1: Identify all value chain activities
Identify each activity that plays a part in creating your company’s finished product. Start with your primary activities, then move on to your secondary activities.
Be sure to cover all the activities in detail. For example, it’s not enough to write down that you have a product design team. You need to dig deeper and ask:
How many designers are on that team?
How much time does each activity on that team require?
What raw materials are they using?
This step will take a considerable amount of time. To speed things up and improve the quality of work, encourage cross-collaboration. That way, each department can outline its logistics, operational costs and services as part of the analysis.
Step 2: Calculate the cost of each value chain activity
The next step is to calculate your cost drivers. This means figuring out how much you spend on running the business, which includes payments such as rent, utilities and staff wages.
By having an accurate picture of every single cost, you can see how you’re spending your money and how much revenue you’re actually generating.
You can also identify which parts of your value chain cost your business the most money.
Let’s use a cup of coffee as a value chain analysis example.
A value chain analysis on a £2.50 cup of coffee reveals that only 1p goes to the actual coffee grower. The remaining £2.49 is made up of additional supplies, such as:
The most critical component (coffee) is one of the least expensive items in the cost breakdown, with rent and staff being the most expensive. Having this information, the company can make informed decisions about where to invest its money and how to grow the business.
Here are a few examples of what the coffee shop owner might choose to do:
To reduce rent costs, finding lower-cost premises could potentially boost their profit margin.
To reduce staff costs, they could reduce staff hours during quiet periods
To boost their value, they could create and promote unique items or source new ingredients (at a similar cost) to add more customer value.
Step 3: Look at what your customers perceive as value
You need to know what your customers want from you. This will help you add the most value to your product or service and allow you to gain a competitive advantage. Without this information, you’re using guesswork to guide your business decisions.
As Rory Sutherland’s TED Talk highlights, the same product can mean very different things to different people. He explains that when it comes to selling a product, there’s no such thing as an objective value. Rather, the value that people place on products comes from factors such as societal influence and group-think.
You can perform market research to get a deeper understanding of your customers’ psychology, their pain points and their needs. In this situation, market research could include anything from hosting an online survey to running a focus group.
Working to understand what your customers want lets you better position your product or service as a solution to their problems.
Step 4: Review your competitors’ value chains
Market analysis is also a great way to determine value as it helps you develop your knowledge of the marketplace and how your competitors are performing. Although it’s unlikely you’ll have access to your competitors’ infrastructure and operational breakdowns, you can use competitive benchmarking as a starting point.
This process involves setting a baseline to review the marketing effectiveness of competitors.
You can choose to use competitive benchmarking in one of three main ways:
Process benchmarking. Comparing your process structure and operations against how your competitors carry out tasks. As mentioned, it’s likely you won’t have access to the ins and outs of their processes, but you can look at industry reports or go through the buying journey to see how their external processes work.
Strategic benchmarking. Reviewing your high-level business strategy alongside your competitors’.Take a look at what works well for them and what doesn’t and see if there’s anything you can learn from it.
Performance benchmarking. Analyzing outcomes, such as revenue, organic traffic, social media performance, reviews and ratings and so on.
For example, the sales and marketing value chain of online companies can be expansive.
By breaking down the rough costs of your competitor’s online sales and marketing efforts, you can calculate whether your spending is too high. McKinsey recommends using a competitor-insight loop to build insight into your competitors’ strategic planning and decision-making processes:
The key to making this process successful is to tap into the latest data from a competitor’s frontline workforce, such as a blog or shared database, and identify value gaps.
Step 5: Decide on a competitive advantage
At this stage, you’ll have a clear understanding of your internal costs, how they stack up to your competitors’ costs and what your customers value. Now, it’s time to identify which type of competitive advantage you want to pursue: cost advantage or differentiation.
If you choose cost advantage, you need to find a way to optimize spending and cut the cost of primary and support activities in your company’s value chain. For example, you might choose to outsource talent, replace certain human activities with workflow automation or look for cheaper delivery services or distribution channels.
The more you can push prices down, the larger your cost advantage will be.
If you choose differentiation, you’ll focus on increasing customers’ perceived value of your product or service. For example, you could upgrade your product to help customers overcome their pain points, repositioning your product as the ultimate solution.
You can also use both types of competitive advantage at the same time to maximize impact. To do this, simply perform your value chain analysis with both areas in mind, reviewing ways to cut costs alongside tactics to gain a competitive advantage.
It can be tricky trying to find a middle ground within these two areas. If you want to make the process easier, consider using a CRM platform like Pipedrive. Using our software, you can create dashboards and reports that allow you to review all this information at a glance.
Apple: a value chain analysis example
To see a value chain analysis in action, have a look at this example analysis of the big tech company Apple.
Apple’s primary activities
1. Inbound logistics
Apple’s supply chain is enormous. Its top 200 suppliers account for 98% of the company’s procurement expenditures for materials, manufacturing and product assembly.
To manage the sheer volume of suppliers and inbound logistics, Apple must run a tight supply chain management ship. As such, the suppliers are held to strict quality standards.
Every year, the list of suppliers is revisited. Suppliers that meet Apple’s standards and provide a more competitive product are added to the list to ensure optimization of its value chain.
To keep their operating costs down, Apple takes advantage of lower labor and raw material costs in Japan and China. Outsourcing also helps the company keep overall manufacturing costs low, which allows it to increase its profit margin
3. Outbound logistics
Apple’s business model allows for products to be purchased online and from the company’s stores.
Because the company has hundreds of retail stores, it can capitalize on keeping any retail margins made through Apple sales. Brand name recognition also means that non-Apple outlets stock the products in large numbers.
4. Marketing and sales
Apple invests a lot in its marketing and sales efforts. As a company, it’s known for its design, quality and innovation when it comes to promoting the brand and advertising new products
The company no longer shares information on its ad spend, but in 2015 its marketing budget rose to $1.8 billion.
Most products sold by Apple are covered by a 1-year warranty and 90 days of support. Customers can book appointments for technical repairs or general product assistance.
The company also staffs its stores with trained Apple technicians who offer customers guided, interactive demos. Store visitors can engage with products and ask the qualified service assistants any questions. As a result, they can see how the products work (which encourages them to buy).
Apple’s support activities
Research and technology development
Apple invests heavily in research and development to maintain its position as a market leader. According to Statista, Apple spent a record $26.25 billion on research and development in its 2022 fiscal year.
Human resource management
Apple has a reputation for offering staff career development, training opportunities and competitive salaries. In 2021, Apple ranked second in a survey ranking the top 50 most admired companies in HR.
The company is also known for recruiting top candidates and even poaching talent from other companies to get the best people working for it.
Conducting a value chain analysis is one of the most powerful processes a business can undertake. When done well, you’ll create a product or service that provides the ultimate customer value while minimizing costs.