Major Strategy Frameworks | Value Chain
As a company strives to create strategies that will increase revenue, they study the processes that affect their production. Deciphering the ways that a company adds value – transforming business inputs into outputs by optimizing the value chain is a fundamental strategy to increase profits. One method used by companies is the Porter’s Generic Value Chain. Knowing how a company can optimize the processes within its value chain, as well as understanding how to increase the efficiency of the production process overall is essential in developing a competitive strategy.
In this article we look at 1) what is Value Chain, 2) when is the Value Chain strategy useful, 3) components of Value Chain strategy, 4) creating the Value Chain strategy, 5) using Value Chain strategy, and 6) example of Value Chain strategy: Starbucks.
WHAT IS VALUE CHAIN
The Value Chain is easily identifiable in the production industry, where a company takes raw material and turns it into a useable product that it sells to customers. It is more difficult to recognize the value chain in other industries. Nevertheless, companies in any industry that wish to find ways to optimize their processes while creating an advantage in the marketplace must study the Value Chain. The Value Chain is used to find potential competitive advantages.
The goal of the strategy is to identify the most valuable activities to the company and take action on the activities which can be improved upon to add competitive advantage. There are two advantages within the value chain: differentiation and cost. A differentiation advantage indicates that a company performs the activities of the business better than the competitors. A cost advantage demonstrates that the company performs business activities for a lower cost, leading to greater profits.
There is a direct relationship: the higher the competitive advantage, the more likely people are to purchase the product or service. Further, the more they buy increases the likelihood of them continuing to purchase from the company. A close scrutiny of a company’s processes can lead to superior products, higher profits and a greater market share through the use of the value chain.
An Introduction To Value Chains
WHEN IS THE VALUE CHAIN STRATEGY USEFUL?
The value chain is useful for any industry that sells products or services to consumers. For the company that wishes to remain competitive in the new global economy, a value chain analysis should be considered mandatory. It can be beneficial to any company that wants to identify areas to reduce costs while adding value or for the company that is seeking to distinguish itself from a sea of competitors. The process of evaluating a value chain can be lengthy. This can be discouraging to a business owner who wants to ‘fix’ whatever is wrong, or who is looking to maximize profits. However, the process will be worth the additional time it requires.
COMPONENTS OF THE VALUE CHAIN STRATEGY
There are two main components of the value chain: primary activities and support activities. Within the two categories are additional processes that help to narrow down the specific areas within a company that adds value.
Primary Activities within Value Chain
The primary value activities are directly tied to the creation, sale, support and maintenance of the product or service. These primary activities will vary depending on the industry or business, but a general look at each one can identify areas that any company encompasses. Primary value activities add value directly to the product.
- Inbound Logistics: The Inbound Logistics component focuses on all of the methods used to bring raw materials, or company inputs, into the business. This can include retrieving, storing and distributing material internally.
- Operations: As the raw material makes it way though the company, Operations adds value by transforming the material into a useable product. This is the stage of the value chain that produces a product for customers.
- Outbound Logistics: Once the product has been completed, the process of moving it from the company to the consumers is called Outbound Logistics. Collecting, storing and distributing products, as well as preparing the company for additional growth is part of this stage of the value chain.
- Marketing and Sales: The methods used to convince consumers to purchase products or services over another’s business are called marketing and sales. Value can be found by the addition of benefits and the success of communicating those benefits to customers.
- Service: After the completion of a sale, the Service component in a value chain considers the value in maintaining their product.
Support Activities within Value Chain
In addition to the primary value activities, the value chain also considers support activities. Support activities are the behind the scenes aspect of a company that indirectly add value to products or services. There are four major components within support activities.
- Firm Infrastructure: This includes the control systems, culture of the company and the overall structure of the organization. Within this component are the company’s accounting systems, administrative organization and other structures that allow the company to operate.
- Human Resource Management: Concerned with the human element of the corporation, this section of the value chain accounts for employee interactions. It encompasses hiring, firing, training and compensation, and is one of the largest components in the value chain.
- Technology Development: An important feature of the value chain, the technology development component regulates technology costs, managing information and maintaining current technology standards.
- Procurement: This component studies how the company acquires the needed resources to operate. It includes vendor and supplier negotiations.
CREATING THE VALUE CHAIN STRATEGY
To create a value chain strategy, it requires careful analysis of the activities that the company engages in to generate revenue. This analysis should be a step-by-step look at the processes that are used during the course of business and will include not only the primary value activities but the support activities as well.
The process of conducting a value chain audit can be performed by a top-level manager, department head or other high-level executive who is looking to increase profits. In addition, it can be handled by a team or advisory committee. Generally speaking, having several people who would be willing to participate in the exercises will provide a more comprehensive look at the company and the opportunities to strategically improve. Once the decision of who will participate in the exercises has been made, the process can begin.
It can be helpful to ‘follow’ a product from the moment the raw materials enter the process until they are purchased by a consumer. Along the way, note the areas where the process can be improved or value can be added. Be sure to include how staffing is recruited and compensated, the use of technologies and customer feedback. It can be helpful to list the items on a chart paper or spreadsheet.
For the listed activities, generate a list of value factors. Value factors are developed from the customer point of view and identify what a customer would consider important. Next to the value factors, detail the methods the company can use to improve in each area. These action steps – the Value Analysis – can be used to formulate a strategy for improving company profits.
USING THE VALUE CHAIN STRATEGY
The Value Chain is a worthless exercise if it is not followed by an analysis and planning of action steps. Depending on the type of advantage the company desires to focus on, the resulting analysis and action plan will have different strategies.
The advantage of a differentiation strategy is found in the production of better products, availability of more features and meeting customer demands. To accomplish this advantage, it may require a higher cost structure, but can ultimately pay off in higher profits if managed correctly. To create an action plan based on differentiation, the Value Chain Analysis is completed with a slightly different approach. The Value Chain Analysis should focus primarily on identifying and optimizing the activities in the process chain that create the most customer value. In addition, the company should focus on adding additional features to their products, while maximizing the customer service experience and increase the potential for customization. The ultimate goal of the value chain strategy for the company desiring differentiation is to generate opportunities for sustainable differentiation.
A company that wishes to compete in the marketplace on cost must evaluate the value chain data from a different perspective.
- An exhaustive study of the primary and support activities of the company must be done – detailing how the work is completed at each step of the process.
- Attached to each part of the process must be the cost of the activity. This allows for inefficiently performed activities or large sources of cost to be recognized and evaluated.
- Evaluation of the cost drivers must be performed for each step of the process as well. Determining what drives the costs allows the company to develop ways of reducing costs at each stage of the production.
- Identification of the connections between the parts of the process can assist the company in the understanding of how cost changes in one part of the process may affect a different part.
- Reduction of cost through the identified areas will generate opportunity for a successful value chain.
After completing a Value Chain Analysis, it can be tempting (and overwhelming) to consider the dozens of areas that can improve value as imperative. Select several easy-to-implement opportunities and put them into motion immediately. This creates excitement and buy-in by the employees who will be enthused with the quick amount of success that can be had. Screen the list of action steps and prioritize them according to feasibility, cost of implementing and necessity. Begin to implement changes according to the strategy type desired. As the marketplace changes, additional evaluation of the value chain may be necessary to maintain a competitive edge.
EXAMPLE OF VALUE CHAIN STRATEGY: STARBUCKS
Understanding the process of a value chain can provide a company with real-time information that can be used to generate increased revenue or gain an advantage over the competition and determine where profit-pitfalls may lurk within the corporate structure.
As an example of a value chain strategy, consider the global coffee supplier, Starbucks.
- Inbound Logistics: As Starbucks’ primary source of revenue, the inbound logistics of their coffee beans is imperative. This requires a high quality of beans, a steady supply chain and a continuous relationship with suppliers in the global market.
- Operations: This aspect of Starbucks’ corporation is handled through direct operations and licensing agreements. The company is almost evenly split between the two, with nearly as many corporate stores as there are franchises. In addition, Starbucks offers its products in retail locations such as grocery and specialty stores.
- Outbound Logistics: Distribution to the company and franchise stores, as well as the retail/grocery stores is the main focus of the outbound logistics.
- Marketing and Sales: With a strong and loyal customer base, Starbucks is able to maximize their marketing efforts through customer loyalty programs, member only incentives and other methods. In addition, they rely heavily on word of mouth advertising and product samples to generate additional sales.
- Service: Customer service at Starbucks is considered to be the pinnacle of the coffee-buying experience. Employees are encouraged to go out of their way to provide exceptional customer service.
- Infrastructure: The infrastructure at Starbucks includes their accounting, legal support and other governmental regulations for establishing locations around the world.
- Human Resources: Considered the largest and most valuable resource Starbucks has, their workforce is highly trained, well compensated and motivated through staff training, competitions and incentives.
- Technology Department: The use of technology within the Starbucks Corporation is essential to the daily operations of the company as well as the long-term effect on the day. Using the latest in technological advances to roast coffee, enhance the customer experience and maximize cost saving is paramount for the company.
- Procurement: Ensuring a steady stream of coffee beans as well as other raw food materials for the local shops is essential to the success of the company. In addition, the development of additional locations, materials and equipment necessary to open those locations will be important. Finally, the development of the materials used in retail locations requires additional materials and supplies that must be obtained.
A value chain is a thorough investigation into a company’s processes, and provides corporate officials the information and tools needed to remain competitive in a changing economy.