Value Chain Analysis and its Relationship to Strategic Cost Analysis

Use a Value Chain Example to Build Your Own

Value chain analysis provides strategic focus. Adding value to a product passing through a chain of activities is called Porter's value chain (after Michael Porter for his discussion of it in Competitive Advantage: Creating and Sustaining Superior Performance). Use a value chain example to improve your business and to build a value chain model.

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What is Value Chain Analysis?

A value chain is a chain of value added activities; products pass through the activities in a chain, gaining value at each stage.

As a small business owner, you need to use value chain models for doing strategic cost analysis (which investigates how your costs compare to your competition's costs).

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What is Strategy? And How Does Porter's Value Chain Model Fit With Strategy?

Strategy is your business' direction; and the how, why, what, who and when of following that direction. Your strategic small business plan needs to include the chain analysis results as strategic action items.

Most businesses analyze their own internal cost structures but most do not analyze their competitor's structures.

Analyze your value chains for your business and then compare to the competitors in your industry that have (in total) up to 80% of the market share - do not spend a lot of time analyzing the smaller competitors unless you believe they are up and coming.

This type of industry analysis will be invaluable for developing and implementing new competitive strategies.

If you are operating in an industry where most competitors are publicly traded, you will be able to access most of their financial statements through their mandated public annual reports.

If your business and/or industry is populated with privately held companies, your cost analysis does not need to include specific costs - it's unlikely your competitor will give you those - but by analyzing where in your competitor's process they must incur cost, you can get a very good idea of your competitor's efficiencies and inefficiencies and you should be able to estimate some of their costs.

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Value Chain Example:

For example, you might have recruited employees who've worked for your competitor and they've told you that they are earning a dollar an hour more with you for the same job they did with the competitor. Or you scan the online job boards for your competitors' job postings.

Labor costs are often a large overall cost in most businesses - at least, you will be able to estimate if they are higher or lower than you.

The value chain identifies, and shows the links, or chain, of the distinct activities and processes that you perform to create, manufacture, market, sell, and distribute your product or service. The focus is on recognizing the activities and processes that create value for your customers.

The importance of value chain analysis is that it can help you assess costs in your chain that might be reduced or impacted by a change in one of the chain's processes. By comparing your value chain to your competitors, you can often find the areas or links of the chain where they might be more efficient than you; that points the direction for you to improve.

However, you need to understand that the value chain will be influenced by the type of small business strategy you and your competitors follow: if you are the high value, high quality market leader, your chain will be quite different than the low cost, high volume competitor. Understand how those differences influence your analysis and make sure that your business strategy is in-tune with your market and with your strategic objectives.

Expect your competitors to have a value chain quite different than yours; because their business grew from a different set of circumstances and a different set of operating parameters than your business.

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How to do a Value Chain Analysis:

(I like to do this type of analysis in a spreadsheet, so that I can add, delete, amend, and sort easily and see the comparative data clearly.)

• include all the primary or direct activities, such as
  1. purchases of supplies, materials, incoming shipping
  2. manufacturing and operations (or if a consumer based business - inventory control and operations)
  3. outgoing shipping and logistics
  4. customer service - includes estimating, coordinating, scheduling
  5. marketing
  6. sales
• then include all the support or indirect activities, such as
  1. accounting and finance
  2. systems support
  3. legal
  4. environmental
  5. safety
  6. human resources (hiring, firing, training, and more)
  7. new product or service research and development
• the last element of your value chain needs to include the profit margin your business (or the product you are analyzing) earns.

Each value chain analysis will be specific to the business and the industry it is in.

In your business, you may need to consider your upstream suppliers (are you getting the best deal, the best quality, etc.) and the downstream end use of the product or service. End-users often have a strong role to play in specifying who gets the business - you need to understand what they value, as well as understand what your direct customers value.

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The reason to do this in-depth type of analysis is to provide you with enough information to be able to see how cost competitive you are and where your cost weaknesses are: this chain analysis leads to a detailed strategic cost analysis.

This information will then lead you to develop strategic actions to reduce or eliminate your weaknesses or disadvantages. Focusing on taking action from the results of your value chain analysis will help your business become more profitable, and may even earn you more market share.

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