Value chain analysis is a method that can help companies of nearly any size and industry boost their profits. One of its biggest merits is that you won't need to hire or outsource skilled professionals to carry it out. You should be able to cope with the task yourself, using your company's internal data.
The value chain analysis is a means of evaluating each of the activities in a business' value chain to detect where opportunities for improvement lie. This term was introduced in 1985 by Michael Porter, a Harvard Business School professor. He wrote a book called "Competitive Advantage". There, he stated that the profit margin of a business is equal to the value created by this business after you deduct the cost of creating that value from it. The bigger the value and the lower the cost of producing it, the higher the profit.
To carry out value chain analysis, you shouldn't focus on any single aspect of the organization's activity. Instead, you should investigate the functioning of the company as a whole. To deliver value to consumers, a business undertakes a certain chain of activities. Thanks to the value chain analysis, you'll get to know the competitive edge of your company and its marketplace differentiation.
Let's explain the same idea with simple words. It doesn't happen so that initially, your product has zero value — but then, it reaches a certain stage of the production cycle and gets 100% of its value. The truth is that the product keeps accumulating its value gradually.
Organizations should be able to benefit from the value chain analysis in two ways.
For instance, your company sells pre-cooked meals. To be able to raise your price tag, you might want to offer more appetizing meals — this will be competitive differentiation. Or you might minimize production costs by signing lucrative contracts with farmers who supply vegetables to you — and this will be cost leadership. To maximize your profit, you can try to combine both approaches.
To make the most of this method, you should carry out value chain analysis on two levels: primary and supporting activities.
The word "primary" denotes anything that directly impacts the input, output or distribution of your product:
Inbound and outbound logistics
Sales and marketing
The term "secondary" refers to:
Research and Development
Human resource management
Mind that these two groups of activities are not separated from each other. They are interrelated: the former impacts the latter and vice versa.
Value chain analysis should help you to detect value gaps in your production cycle and take measures to fill them.
Let's carry out a brief value chain analysis using the example of the Apple company. This brand often discloses facts and figures that characterize its performance, so it should be easy for us to examine it.
Apple's supply chain includes hundreds of contractors. Yet 98% of procurement expenditures are distributed among the top 200 suppliers. Every year, the company revises its list of suppliers. To streamline the process, top managers introduced the Procurement Program, which regulates quality standards.
This brand manufactures its product in countries where labor and raw material costs are low — namely, in China and Japan. Such an approach helps Apple to minimize overall manufacturing costs.
Consumers can purchase Apple products either online or in hundreds of brick-and-mortar stores. Most other brands today can't afford to maintain such a large chain of offline venues. But precisely because its chain is so huge, Apple manages to keep it profitable. Besides, third-party shops buy iPhones and Macs in large batches because the demand for them has been steadily high.
The brand's marketing strategies are focused on three values: design, quality and innovation. It sets the benchmark for all gadget manufacturers because it knows best how to highlight the value of its products. Apple strives to turn each ad into a piece of art and signs contracts with the most relevant influencers.
When you buy an Apple gadget, you typically get 90 days of support and a 1-year warranty. At any moment, you can visit a brick-and-mortar store to ask a skilled technician to check your gadget. This kind of approach considerably increases customers' engagement.
In 2020, 7 new or refreshed Apple products hit the market. To be able to churn out gadgets at such a pace, the manufacturer needs to invest a huge budget in research and development.
In 2019, this brand got the reward for being the most admired company for HR. Apple always strives to hire the best professionals in the industry. They frequently poach talents from their competitors and pay them very well.
When you start to conduct value chain analysis for any other company, you can stick to the same logic.
Step 1: Identify all value chain activities
List all the activities that enable you to create your product. But you shouldn't just enumerate them. You need to characterize every activity — for instance, by answering the following questions.
Which raw materials do you use and in which amounts?
How many people work in a particular department?
What are the biggest challenges that that department has to cope with?
And so on
The easiest way to collect this information is to ask each department of your company to fill in the questionnaires that you send to them.
Step 2: Estimate the cost of each activity
This should enable you to estimate your overall revenue. Plus, you'll identify those elements of your value chain that involve the highest expenses.
The results of this stage of the value chain analysis often surprise business owners. They might think that purchase of raw materials is the costliest part of the process. But in fact, they might spend the most money on staff salaries. Even if these are minimum wages, the company might have too many staff members. In this case, the business owner should think of automating processes. For instance, they can replace live specialists of their support service with chatbots.
Sometimes, it might be impossible to cut down expenses. Then, organizations should strive to boost the perceived value of their products. For instance, they might emphasize their compliance with ecological standards or release limited collections of items.
Step 3: Find out what the consumers perceive as the main value of your product
Many people buy fake designer bags because they can't afford the originals. They can legally purchase bags by lesser-known manufacturers at the same price — but they don't want them. For such consumers, it's not the looks and quality of their bags that matter. They pay for the sense of belonging to a fashion-savvy community.
Rather often, businesses keep selling products and receiving income without realizing why their clients stay loyal to them. The owner of a company, its staff and its clients might perceive the same goods or services completely differently.
Let's come back to the value chain example of the company that sells pre-cooked meals. You might think that consumers love your best-selling breakfasts because they are cheap, wholesome and taste good. But from your customers' point of view, these meals might seem cool because the protagonists of a popular movie series love them. Groupthink and societal influence are among the primary factors that impact people's purchasing behavior.
To understand the real driving forces behind your customers' decisions, you should conduct qualitative and quantitative analysis (which is not synonymous to value chain analysis). Your goal is to identify statistical patterns and adjust your product to better cater to your clients.
Plus, the same patterns will facilitate the search of new customers for your sales reps. Your staff member will better understand the demands and preferences of your target audience and will be able to cater to them more efficiently.
Step 4: Analyze your competitors' value chains
Most likely, your competitors keep their insider information strictly confidential. Nevertheless, you might be able to check their blogs or shared databases. However, you don't even need to know their expenses or KPIs. Instead, you can rely on competitive benchmarking.
At this stage of value chain analysis, you can compare the following aspects of your competitors' businesses:
You set benchmarking goals, carry out research, compare parameters and determine value. Thanks to such an approach, you'll be able to roughly estimate your competitors' expenses. If they spend less money than you on certain activities, you might consider copying their methods.
Step 5: Understand your competitive edge
Now, you should clearly realize the strong and weak sides of your business. It's time to take action! Remember that value chain example with the company that sells pre-cooked meals? To cut down expenses, you might want to close your offline locations with a costly rent and switch to cheaper dark kitchens. You might try to rebuild from scratch your system of accepting and processing online orders. You might sign lucrative contracts with suppliers. You can take any other measure that will help you to differentiate yourself from your competitors and earn a larger income.
At the final stage of the value chain analysis, you should exercise your creativity. On the Internet, you should be able to find dozens of cases that are relevant to your industry and use them as your sources of inspiration.
Hopefully, this article came in handy and now you better understand the essence and benefits of value chain analysis. As you see, this method is rather simple and its results are compelling. Thanks to it, you should be able to optimize your processes, cut down expenses and maximize your profit. The sooner you try to apply it, the quicker you should be able to benefit from it.