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Idea 47 - Value chain

 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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