Idea 47 - Value chain
Michael Porter, who has given management more big ideas than anyone since
Peter Drucker, is unyielding on the subject of being competitive. If a company
wants competitive advantage, he insists, it must examine every little thing it
does through the prism of competitiveness. His five forces model was a tool for
assessing the strength of competition outside the factory gate. To help analyse
a firm's internal· competitiveness, he developed his concept of the value
chain.
Porter
saw all the interrelated activities that create a product or a service as links
in a rather complex chain. Each has a cost, and each adds value to the end
product. The firm wants to sell the end product to the customer at a price - an
aggregated level of value - that exceeds the sum of the costs. The difference
will be its profit margin. To maximize that difference, Porter urged companies
to analyse the competitiveness of each link in the chain. He divided the firm's
activities into two types:
Primary activities are directly concerned with making the product or delivering
the service. These comprise:
·
inbound logistics - receiving and storing raw materials from
suppliers, and then distributing them to where they are needed;
·
operations - assembling or manufacturing the finished
product, or delivering the service;
·
outbound logistics - storing and distributing the finished
products
·
marketing and sales - activities aimed at persuading the
customer to buy the product, including pricing, channel selection and
advertising;
·
service - support for customers after they have bought the
product, including installation, after-sales service and complaints handling.
Support activities help to improve the efficiency or effectiveness of the
primary activities. These are:
·
procurement - the purchasing of all goods, raw materials and
services needed to create the product or service (the 'value-creating'
activities);
·
technology development - research and development, automation
and other use of technology to support value-creating activities;
·
human resource management - recruiting and selecting
employees, training, developing, motivating and paying them;
·
firm infrastructure - organization and control, finance,
legal and information technology.
The
firm can gain competitive advantage by carrying out these strategically
important activities more cheaply or better than its competitors. The
activities are connected by linkages, through which the performance or cost of
one affects another. These linkages are very important, and include flows of
information as well as goods and services. Marketing and sales, for example;
must deliver timely and realistic sales forecasts to different departments.
Only then can procurement order the right quantities ~f raw materials to arrive
on the right date. Inbound logistics will be prepared and operations can
schedule production so that deliveries can be met.
Another
example of linkages in action would be if a product were redesigned to reduce
manufacturing costs - but then was found inadvertently to have increased
service costs. The more efficiently the firm can perform value chain activities
and manage its linkages, the more it will boost its margin - or, as Porter
would say, 'generate superior value'.
Understanding
costs Value chain analysis is useful in pursuing either of Porter's two generic
competitive strategies - cost advantage or differentiation. Its focus on
separate activities should lead to a better understanding of cost, and how to
squeeze it out of a particular part of the chain. It also helps the company to
decide which activities it can perform better than its competitors, suggesting
opportunities for differentiation. Value chain analysis can also highlight
activities where outsourcing might be a sensible option.
The
firm can build a cost advantage by reducing the cost of individual activities
in the value chain, or by reconfiguring the value chain. Reconfiguring might
mean introducing a new production process or new distribution channels. For
instance, Federal Express reconfigured its value chain, and transformed the
express freight business, by buying its own planes and developing a hub and
spoke structure.
Porter
picked out a number of factors that could affect cost in value chain
activities. They include: economies of scale, capacity utilization, linkages
among activities, learning, interrelationships among business units, degree of
vertical integration, timing of market entry and geographic location. Control
these more effectively than your competitors and you can create a cost
advantage.
A
firm that has chosen to differentiate can look for advantage in any part of the
value chain. In procurement, for example, a rare or unique input could create
differentiation. So could distribution channels that offer high levels of
customer service. Reconfiguring the value chain to achieve differentiation
might involve some form of vertical integration - acquiring a customer or
supplier. Uniqueness is what differentiation is all about - but differentiation
demands creativity and can often cost more.
Porter
singled out various drivers of uniqueness, noting that many of them were also
cost drivers. They included: policies and decisions, linkages, timing,
location, interrelationships, learning, integration and scale. A firm's value
chain is not an island. It is part of a wider system of value chains - those of
suppliers, of channels and customers. Together they make up what Porter calls
the 'value system'.
Linkages
exist between the chains, and they may be more or less formalized. Vertical
integration - acquiring suppliers or customers - can help to extend control
here, but coordination is possible in other ways. Motor component suppliers
might agree to build their plants close to a car manufacturer, for example. In
much the same way as it must manage internal linkages, a firm's ability to
create and keep a competitive advantage will also depend on how well it is able
to manage external linkages, and to manage the whole value system of which it
is a part.
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