Value chain analysis is a powerful tool for managers to identify the key activities within the firm which form the value chain for that organization, and have the potential of a sustainable competitive advantage for a company. Therein, competitive advantage of an organization lies in its ability to perform crucial activities along the value chain better than its competitors.
The value chain analysis essentially entails the linkage of two areas. Firstly, the value chain links the value of the organizations’ activities with its main functional parts. Then the assessment of the contribution of each part in the overall added value of the business is made.
In order to conduct the value chain analysis, the company is split into primary and support activities (Figure 1). Activities are divided into 2 groups. One group is related with production (primary), while the other group’s activities are those that provide the background necessary for the effectiveness and efficiency of the firm (Support). Moreover, the goal of these activities is to offer the customer a level of value that exceeds the cost of the activities, thereby resulting in a profit margin. Such two groups is explained in detail as follows:
Figure 1: Value Chain Activities
The support activities of a company include the following:
Procurement: This function is responsible for purchasing the materials that are necessary for the company’s operations. An efficient procurement department should be able to obtain the highest quality goods at the lowest prices.
Human Resource management: This is a function concerned with recruiting, training, motivating and rewarding the workforce of the company. Human resources are increasingly becoming an important way of attaining sustainable competitive advantage.
Technology Development : This is an area that is concerned with technological innovation, training and knowledge that is crucial for most companies today in order to survive.
Firm Infrastructure: This includes planning and control systems, such as finance, accounting, and corporate strategy etc.
Porter used the word ‘margin’ for the difference between the total value and the cost of performing the value activities (Figure 1). Here, value is referred to as the price that the customer is willing to pay for a certain offering. Other scholars have used the word ‘added value’ instead of margin in order to describe the same. The analysis entails a thorough examination of how each part might contribute towards added value in the company and how this may differ from the competition.
In a study of Saudi companies, Ghamdi (2005) found that 22% of the companies in the study used value chain frequently, while 17% reported that they somewhat used it, and 42% did not use the tool at all. An interesting finding of the study was that the manufacturing firms were frequent users of the tool compared to their service counterparts (Ghamdi, 2005).
Value-Chain Analysis and firm’s core competencies
The value chain model is a useful analysis tool for defining a firm’s core competencies and the activities in which it can pursue a competitive advantage as follows:
A firm may create a cost advantage either by reducing the cost of individual value chain activities or by recon8figuring the value chain.
Once the value chain is defined, a cost analysis can be performed by assigning costs to the value chain activities. The costs obtained from the accounting report may need to be modified in order to allocate them properly to the value creating activities.
Porter identified 10 cost drivers related to value chain activities:
Economies of scale.
Linkages among activities.
Interrelationships among business units.
Degree of vertical integration.
Timing of market entry.
Firm’s policy of cost or differentiation.
Institutional factors (regulation, union activity, taxes, etc.).
A firm develops a cost advantage by controlling these drivers better than do the competitors. A cost advantage also can be pursued by reconfiguring the value chain. Reconfiguration means structural changes such a new production process, new distribution channels, or a different sales approach. For example, FedEx structurally redefined express freight service by acquiring its own planes and implementing a hub and spoke system.
A differentiation advantage can arise from any part of the value chain. For example, procurement of inputs that are unique and not widely available to competitors can create differentiation, as can distribution channels that offer high service levels.
Differentiation stems from uniqueness. A differentiation advantage may be achieved either by changing individual value chain activities to increase uniqueness in the final product or by reconfiguring the value chain. Porter identified several drivers of uniqueness as follows:
Policies and decisions.
Linkages among activities.
Scale (e.g. better service as a result of large scale).
Many of these also serve as cost drivers. Differentiation often results in greater costs, resulting in tradeoffs between cost and differentiation.
There are several ways in which a firm can reconfigure its value chain in order to create uniqueness. It can forward integrate in order to perform functions that once were performed by its customers. It can backward integrate in order to have more control over its inputs. It may implement new process technologies or utilize new distribution channels. Ultimately, the firm may need to be creative in order to develop a novel value chain configuration that increases product differentiation.
Value Chain & the Wider Systems
A firm’s value chain is part of a larger system that includes the value chains of upstream suppliers and downstream channels and customers. Porter calls this series of value chains the Value System, shown conceptually below:
Figure 2 .The Value System
Outsourcing Value Chain Activities
Whether the activity can be performed cheaper or better by suppliers.
Whether the activity is one of the firm’s core competencies from which stems a cost advantage or product differentiation?
The risk of performing the activity in-house. If the activity relies on fast-changing technology or the product is sold in a rapidly-changing market, it may be advantageous to outsource the activity in order to maintain flexibility and avoid the risk of investing in specialized assets.
Whether the outsourcing of an activity can result in business process improvements such as reduced lead time, higher flexibility, reduced inventory, etc.
Technology and the Value Chain
The value chains of companies have undergone many changes over the last two decades, due to the rapidly changing business environment. Information technology and the Internet have played a fundamental role in transforming certain parts and the interlinking between parts of the value chains of companies today.
Because technology is employed to some degree in every value creating activity, changes in technology can impact competitive advantage by incrementally changing the activities themselves or by making possible new configurations of the value chain.
IS/IT in Value Chains
Today there are a lot more ways IS and IT support value chains and reconfigure value networks. For example Enterprise Resource Planning Software (ERP), Customer Relationship Management Software (CRM) and Supply Chain Management Software (SCM) help organizations making their primary activities and support activities more efficient. Furthermore these Software Solutions also interact with value networks and therefore are mighty tools for organizations.
Various IS technologies are used in both primary value activities and support activities as follows:
Computer Aided Manufacturing
Online Data Entry.
Marketing & Sales
E-Business & E-Commerce
Diagnostic Expert System.
Automated Office Systems
HR DBs & Online Recruitment.
Data Interchange with suppliers.
Case Study: Zara Fashion House
Zara and Lands’ End are two retailers that differ in their sales approach; however, both companies successfully implemented information technology in their respective companies to enhance their value chains.
The value chain in the fashion industry is extremely complex. Through inbound logistics materials and fabrics will be shipped to clothing manufacturers. The operations stage necessitates the mass-production of goods, because it is more cost-effective for manufacturers to do so. Outbound logistics is typically a three-step process. The goods are first imported into the country where they will be sold, as most fashion retail manufacturing takes place in other countries to take advantage of low labor costs. Next, the retailer will purchase these goods directly through the manufacturer or importer.
Finally, the goods will be sold to the consumer through a bricks and mortar location in the case of Zara; or they may be shipped to consumers as is the case with Lands’ End. Sales and marketing activities involve promotion and sales of the firm’s products, either to new or repeat customers. The last activity in the value chain is service, which involves the maintenance of manufacturing and retail equipment.
Zara has used information technology to successfully speed up the entire value chain process. In other words, while it takes the typical retailer 9 to 12 months to develop a fashion concept and see it through to the point where the goods arrive in the store, Zara has streamlined the process so much that it takes about a quarter of that time.
One way that Zara accomplishes this is by using information systems in their stores to feed the design team innovative ideas. Store associates will frequently see new fashion or fabric ideas and send them over the Internet to Zara’s headquarters. All of this information heads into a database at the head office. The constant monitoring and updating that occurs gives designers a heads up over the competition in developing new styles.
One major difference between Zara and other fashion retailers is that they don’t outsource their manufacturing to other countries where the labor may be cheaper. However, its distribution system is so high-tech that there is little human involvement required. For example, instead of relying on workers to sort through articles of clothing, Zara uses optical reading devices to accomplish this task, which leads to a tremendous cost savings in the form of labor.