What's your business' competitive edge? A value proposition helps businesses identify what sets it apart from competitors. But how can you tell if your business activities are creating the most value for customers and a great profit margin?
Jump to Usefulness of value chain analysis - Under the value chain analysis, a typical industry value chain incorporates three things.
A value chain is used to describe all the business activities it takes to create a product from start to finish (e.g., design, production, distribution, etc.). And a value chain analysis gives businesses a visual model of these activities.
With this analysis, you can take steps to create a competitive advantage, improve efficiency, and increase profit margins. Let's take a deeper look into value chain analysis and learn how you can analyze your business activities.
What Is Value Chain Analysis?
Value chain analysis is a way for businesses to analyze the activities they perform to create a product. Once the activities are analyzed a business can use the results to evaluate ways to improve its competitive advantage.
Competitive Advantage
Competitive advantage is what sets your business apart from competitors. And to develop an advantage, you'll need a clear idea of your target market, the benefit your product provides to the target market, and a solid understanding of your competitors and their offerings.
A business can gain a competitive advantage in one of the following areas.
1. Cost Leadership
The goal of a cost leadership strategy is to become the lowest-cost provider in your industry or market. Companies who excel with a low-cost strategy have extreme operational efficiency and use low-cost materials and resources to reduce the overall price of their product or service.
Cost leadership examples: McDonald's and Walmart
2. Differentiation
With a differentiation strategy, the competitive advantage is gained by offering a unique or highly specialized product or service. The business needs to dedicate time and resources to innovation, research, and development. A successful differentiation strategy allows the business to set a premium price for its product or service.
Differentiation examples: Starbucks and Apple
It's best to pick a single competitive advantage to focus efforts on. Depending on which competitive strategy you choose the goal of your value chain analysis will be to either reduce costs or differentiate to improve margins. Then you'll have a clear idea of your business' goals, how you plan to provide value, and it narrows the scope of changes that might need to be made to improve efficiency.
Porter's Value Chain Analysis
Harvard Business School professor, Michael Porter, introduced a simple value chain model in his book, 'Competitive Advantage'. He developed the steps to perform a value chain analysis and split business activities into two categories: primary and support.
Value Chain Analysis Steps
Value chain analyses require research and can take time to develop. Below are the general steps it takes to create a value chain analysis:
1. Determine the business' primary and support activities.
Together, the primary and support activities make up the value chain. And they include each action required in the development of a product or service, from raw material to final product.
2. Analyze the value and cost of the activities.
The team tasked with creating the value chain analysis should brainstorm ways each activity provides value to customers and the business as a whole. Compare the activity to the competitive advantage you're trying to achieve (cost leadership or differentiation) and see if it supports the goal.
After the value analysis is complete, take a look at the cost of the activities. Is the activity labor intensive? How much does X raw material cost? Asking questions similar to these will help identify which activities are cost-effective and which are not. This where areas for improvement can be identified.
3. Identify opportunities to gain a competitive advantage.
Once the value chain analysis is complete, the primary stakeholders in the business can see an overview of where the business is excelling and where improvements can be made operationally.
Begin with the improvements that take minor changes and provide high-impact results. After the easy wins are identified and actioned, you and your team can tackle the bigger challenges that might be hindering efficiency.
The value chain analysis gives businesses a clear idea of how to adjust their actions and processes to provide the most value to their target market and increase profit margins for the company.
Primary and Support Activities
Identifying the primary and support activities is the first step in creating a value chain analysis. These are the key processes and systems a business uses to develop is product or service.
Primary Activities
There are five primary activities and they include all the actions that go into the creation of a business' offering.
1. Inbound Logistics
![Chain Chain](/uploads/1/2/5/2/125288171/426160195.png)
This is how materials and resources are gained from suppliers before the final product or service can be developed.
2. Operations
Operations are how the materials and resources are produced, resulting in a final product or service.
3. Outbound Logistics
Once a product or service is finished, it needs to be distributed. Outbound logistics describes this delivery process.
4. Marketing and Sales
This is how your product or service is presented and sold to your ideal target market.
5. Services
This is the support a business provides for the customer which can include support and training for the product, warranties, and guarantees.
Support Activities
Support activities help the primary activities in creating an advantage over competitors, and they include:
1. Firm Infrastructure
This entails all the management, financial, and legal systems a business has in place to make business decisions and effectively manage resources.
2. Human Resource Management
Human resource management encompasses all the processes and systems involved in managing employees and hiring new staff. This is especially important for companies that provide in-person service, and excellent employees can be a competitive advantage.
3. Technology Development
Technology development helps a business innovate. And technology can be used in various steps of the value chain to gain an advantage over competitors by increasing efficiency or decreasing production costs.
4. Procurement
This is how the resources and materials for a product are sourced and suppliers are found. The goal is to find quality supplies that fit the business' budget.
Value Chain Analysis Example
Value chain analysis allows businesses to examine their activities and find competitive opportunities. For example, McDonald's mission is to provide customers with low-priced food items. And the analysis helps McDonald's identify areas for improvement and activities that add value to their products and services or activities.
Below is an example of a value chain analysis for McDonald's and it's cost leadership strategy.
Inbound Logistics
McDonald's has pre-selected, low-cost suppliers for the raw materials for their food and beverage items. It sources suppliers for items like vegetables, meat, and coffee.
![Analysis Analysis](/uploads/1/2/5/2/125288171/596142054.jpg)
Operations
The business has is a franchise and each McDonald's location is owned by a franchisee. There are more than 37,000 McDonald's locations worldwide.
Outbound Logistics
Instead of formal, sit-down restaurants, McDonald's has fast-casual restaurants that focus on counter-service, self-service, and drive-through service.
Marketing and Sales
Its marketing strategies focus on media and print advertising, including social media posts, magazine advertisements, billboards, etc.
Services
McDonald's strives to achieve high-quality customer service. And it provides its thousands of employees with in-depth training and benefits so they can best assist their customers.
Value Chain Analysis Template
Here are a few value chain analysis templates from Edraw to help you develop your own.
1. Porter's Value Chain Analysis Model
Source: Edraw
This Porter's value chain analysis template provides a general overview of business activities.
2. Template for Cost Profit Margin
Source: Edraw
If you're analyzing the cost versus expected profit margin from your primary and support activities, this template's for you.
3. Template for Educational Institutions
Source: Edraw
Rather than analyzing the activities that go into creating a product or service, this model looks at the value chain involved in developing academic research.
4. Template for Products
Source: Edraw
Use this template to analyze the activities it takes to create a product from raw material to finished product.
5. Template for Financial Acquisitions
Source: Edraw
Did you recently acquire or merge with another business? If so, use this template to analyze the steps in the transition.
Your value chain analysis will help you identify areas for improvement and the activities that provide the most value to the customer and business as a whole. Eliminating inefficient business activities speeds up production, improves your competitive advantage, and increases profit margins.
If you're an entrepreneur who's interested in clearly defining your business' target audience and market, check out these steps to find the ideal niche market next.
Why do some companies’ profit margins exceed their competitors? How does one company garner a competitive advantage against its peers? The answers to these questions may be found in value chain analysis.
Value chain analysis is the process of looking at the activities that go into changing the inputs for a product or service into an output that is valued by the customer. Companies conduct value-chain analysis by looking at every production step required to create a product and identifying ways to increase the efficiency of the chain.
Porter's Value Chain Analysis
Back in 1985, Michael Porter, a Harvard Business School professor, introduced a basic value chain model in his book Competitive Advantage. He identified several key steps common among all value chain analyses and determined that there are primary and supporting activities that when performed at the most optimal levels will create value for their customers, such that the value offered to the customer exceeds the cost of creating that value, resulting in higher profit. Porter’s framework groups activities into primary and support categories
The primary activities focus on taking the inputs, converting them into outputs and delivering the output to the customer. The support activities play an auxiliary role to the primary activities. When a company is efficient in combining these activities to deliver a superior product or service, then the customer is willing to pay more for the product than the cost to make and deliver the product which results in a higher profit margin.
Let’s work through an example of an asset management firm. The goal of the client is to achieve the highest possible return on investment within the guidelines and restrictions set forth by the client.
The firm’s primary activities include:
- Investment team (portfolio managers, analysts) – tasked with making the investment decisions.
- Operations and traders – tasked with ensuring the investments are in line with the guidelines set forth by the client and the trades are at the best execution price.
- Marketing and sales – responsible for procuring clients.
- Service (client relationship management) – responsible for providing all the touch points to the client.
Support activities include:
- Technology – designs a trading and client module that is efficient and effectively allows the team to provide the highest level of service and make the best investment decisions.
- Human Resources – finds and retains the highest level of talent at the firm.
- Infrastructure – includes the lawyers and risk managers whose oversight is crucial to ensuring the client’s guidelines are followed, the investment risk is controlled and the firm is operating within the regulations established by the SEC.
How to Improve the Value Chain
When a firm takes into account its value chain, it needs to consider its value proposition, or what sets it apart from its competitors. Value chain analysis is designed to improve profits by creating a product or service that is so superior that customers are willing to pay more than the cost to create it.
But improving a value chain for the sake of improvement should not be the end goal. Instead, a company should decide why it wants to improve its value chain in the context of its competitive advantage in order to differentiate itself among its peers.
Two common competitive advantage strategies include low cost provider or specialization/differentiation of product or service.
- Low cost provider – value chain analysis focuses on costs and how a company can reduce those costs.
- Specialization – value chain analysis focuses on the activities that create a unique product or differentiation in service.
Let’s go back to our asset management example. After the value chain is identified, then the asset manager should determine its competitive advantage and pursue activities that go towards reaching those goals. In this case, the asset manager wants to pursue a strategy of differentiation by delivering a product that has steady, top quartile returns over three years.
Based on the drivers of uniqueness Porter identified, the firm needs to focus on its policies and decisions and learn to differentiate itself in terms of performance. By focusing on these drivers, the two primary activities of the investment team, operations and the traders along with all the identified support activities can manage a product that achieves its differentiated competitive advantage.
The Bottom Line
Value chain analysis is an extremely useful management tool which identifies the activities that go into creating a superior product or service that is highly valued by customers. The outcome of creating this highly valued product is that customers are willing to pay a premium, which exceeds its costs, thereby delivering higher profit.
The usefulness of this model created by Michael Porter is mostly seen in its ability to breakdown work product into various activity groups to strategically focus the management on what are truly useful activities, and what creates value. It also concentrates a company to determine a vision utilizing a competitive advantage strategy which will drive future products and services. Supporting activities are further validated in the process, creating an understanding that these sometimes overlooked activities are integral to the value chain and value proposition for a company.