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Understanding a firm's value chain is crucial for strategic decision-making. A firm's value chain is a series of activities that create value for the customer.
It's a complex system, but one that can be broken down into distinct stages. These stages include inbound logistics, operations, outbound logistics, marketing and sales, and service.
Each stage is critical to the overall success of the firm. By analyzing and optimizing these stages, firms can increase efficiency and reduce costs.
What Is a Firm Value Chain?
A firm's value chain is a series of functional activities that add value to its customers.
The concept of a value chain was created by Michael Porter, a Harvard Business School professor, around 1985.
The value chain consists of primary activities and support activities, all of which add value to the products or services offered by the business.
Each activity in the value chain adds value to the products as they pass through, ideally creating a cumulative effect that exceeds the sum of individual values.
The goal of managing a value chain is to optimize the chain to maximize value while minimizing cost.
A business must use its value chain activities to create value and then capture that value.
Value created by the chain should exceed the sum of values added by each individual activity.
Components of a Firm Value Chain
A firm's value chain is made up of various departments that work together to support the entire process. This includes planning & strategy, finance, accounting, legal, marketing, quality control, and more.
These departments should all be working towards the same goals to ensure congruence and optimal performance. Infrastructure supports the entire value chain rather than individual activities.
Inbound logistics is a key component of the value chain, including the processes of receiving, distributing, and storing products internally. This involves sourcing raw materials and managing supplier relationships.
Procurement is also a part of the value chain, focusing on sourcing raw materials from suppliers.
Typical Include:
A firm's value chain is made up of several key components, which work together to create a competitive advantage.
Typical include: inbound logistics, which encompasses the processes of receiving, distributing, and storing products internally. This includes sourcing raw materials, such as stainless steel and copper, and managing supplier relationships.
Marketing and sales are also crucial components of a firm's value chain. This includes activities like advertising, promotion, sales forces, quoting, channel selection, channel relations, and pricing.
Secondary or support value chain activities, such as procurement, HR management, technology, and infrastructure, are also essential. Procurement, for example, involves sourcing raw materials from suppliers.
The value chain is not just about delivering products, but also about creating value for customers. Marketing and sales strategies focus on maximizing revenues, while operations aim to minimize costs.
Inbound logistics is the first primary element of the value chain, and it involves the receipt of raw materials or inputs of production. A strong Enterprise Resource Planning (ERP) system can help manage inventories and order sizes more efficiently.
Marketing and sales activities, such as advertising and promotion, aim to induce buyers to purchase a product. Examples include advertising, promotion, sales forces, quoting, channel selection, channel relations, and pricing.
A good marketing campaign can drive demand and ensure there are customers for a product or service. Sales strategies depend on the industry and aim to show value to prospective clients or customers.
Human Resource Management
Human Resource Management plays a crucial role in determining the skills and motivation of employees and the cost of hiring and training them.
The activities involved in HRM include recruiting, hiring, firing, training, development, and compensation of all types of personnel.
Some companies rely heavily on talented employees, especially in the technological and advisory service industry, that they have devoted an entire Talent Management department within HRM.
HRM can greatly affect a company's competitive advantage, making it a great investment to find the right people for your business.
Procurement, a secondary value chain activity, is the sourcing of raw materials from suppliers, which supports each phase of the value chain.
HRM is a key support activity that works alongside procurement to ensure the smooth operation of the value chain.
By investing in HRM and procurement, companies can gain a competitive advantage and achieve their business goals.
Steps
To create a strong firm value chain, it's essential to break down the process into manageable steps.
The first step is to identify and map out the different stages of the value chain, which can include inbound logistics, operations, outbound logistics, marketing and sales, and service.
Each stage should be analyzed to determine its key activities, which are the specific tasks that add value to the product or service.
For example, in the inbound logistics stage, key activities might include receiving and inspecting raw materials.
The next step is to identify the key resources required to support each stage, such as employees, equipment, and technology.
In the operations stage, key resources might include manufacturing machinery and a skilled workforce.
The following step is to determine the key capabilities needed to execute each stage, such as quality control and supply chain management.
In the marketing and sales stage, key capabilities might include market research and customer relationship management.
Finally, the last step is to establish a system for measuring and evaluating the performance of each stage, including key performance indicators (KPIs) such as cost, quality, and delivery time.
By following these steps, a firm can create a clear and effective value chain that drives business success.
Cost and Product Differentiation
Cost and Product Differentiation are two key strategies that can give your firm a competitive edge. Companies that focus on product differentiation can charge a premium price due to their unique offering or specialized finished product.
This strategy is often the result of research and development, allowing innovative companies to create innovative products. In the fourth industrial revolution, mass personalization is expected to become a leader in product differentiation strategies.
To achieve cost and product differentiation, it's essential to identify areas in your value chain where you can improve margins. Companies should focus on optimizing high-cost, low-value processes, regardless of their focus on differentiation or cost reduction.
Here are the two criteria to consider when analyzing your value chain for competitive advantage:
- The activity is not performed by competitors
- The activity is performed superiorly than similar activities performed by competitors
By focusing on these areas, you can increase profit margins while providing utmost customer satisfaction with a final product that meets their expectations.
Product Differentiation
Product differentiation is a key strategy for businesses to stand out from the competition. It's about offering a unique product or service that sets you apart and allows you to charge a premium price.
A company can achieve product differentiation through research and development, resulting in innovative products that are not easily replicable by others. This is especially true in the fourth industrial revolution, where mass personalization is becoming a leader in product differentiation strategies.
Apple is a great example of a company that has mastered product differentiation. They focus on creating high-quality products that are not only functional but also aesthetically pleasing, as seen in their "shot on iPhone" commercials and photography.
To gain a competitive advantage through product differentiation, a company must either perform an activity that its competitors do not, or perform it superiorly to its competitors.
Here are the two criteria for competitive advantage through product differentiation:
- The activity is not performed by competitors
- The activity is performed superiorly than similar activities performed by competitors
Cost Reduction vs. Product Differentiation
Companies can either focus on reducing costs or differentiating their products.
Cost reduction is a strategy where companies aim to become the lowest cost option for the end user, often by using low-cost materials and offshore manufacturing. McDonald's dollar menu and generic brands in stores are examples of cost reduction.
Product differentiation, on the other hand, is about creating a unique offering or specialized product that enables companies to charge a premium price. Innovative companies like Apple and Louis Vuitton are known for their product differentiation strategies.
Companies are typically focused on either product differentiation, which requires a bigger investment in support activities, or cost reduction, which is mainly about optimizing primary activities.
Analyzing the cost and value of each activity is crucial in creating a value chain analysis. This involves looking at the cost drivers of each step and determining whether certain activities are low value but high cost.
By analyzing both the cost advantages and profit margins of each activity and the value it provides to the organization, companies can holistically understand how to optimize each activity.
Companies should first focus on optimizing high cost, low value processes regardless of their focus on differentiation or cost reduction.
Benefits and Implementation
A well-executed Value Chain Analysis provides several unique advantages for businesses by offering a detailed and structured framework for optimizing operations and enhancing value creation.
These benefits include comprehensive process optimization, allowing companies to identify inefficiencies and streamline processes, leading to significant cost savings and other such benefits.
By aligning operations with customer needs, businesses can ensure that every step adds to the overall customer experience, improving satisfaction and loyalty, and leading to a competitive advantage.
A Value Chain Analysis can help you identify areas where you can cut costs and improve efficiency, which is essential for staying competitive in today's fast-paced market.
You can use Value Chain Analysis in several scenarios to optimize business performance, including driving efficiency, boosting customer value, gaining a competitive edge, responding to market changes, and developing or refining strategic plans.
Here are some specific scenarios where Value Chain Analysis can be particularly useful:
Scenario | Description |
---|---|
Drive efficiency | Helps identify inefficiencies and areas for improvement |
Boost customer value | Provides insights into how each stage contributes to the final product or service |
Gain a competitive edge | Helps analyze where value is created within your operations and leverage this knowledge for strategic advantage |
Respond to market changes | Enables your business to adapt quickly by reevaluating and adjusting processes and strategies |
Develop or refine strategic plans | Offers detailed insights into how various activities contribute to your strategic goals, aiding in effective decision-making and resource allocation |
With the right tools and expertise, you can conduct a Value Chain Analysis and gain valuable insights into your business operations, enabling you to make informed decisions and drive growth.
Firm Value Chain Framework
Michael Porter's value chain model was established in his 1985 book Competitive Advantage. It helps create the equation that leads to calculating margins, which are the revenue generated from the value chain.
The value chain framework is a strategic tool for business management that identifies activities that add value to the business and those that don't. It divides activities into primary and support activities.
Primary activities include inbound logistics, operations, outbound logistics, marketing and sales, and service. These activities are crucial to creating value for customers.
Support activities include firm infrastructure, human resource management, technology development, and procurement. These activities are essential to the production of goods and services.
The value chain framework is designed to be more accommodative of different business models, making it a valuable tool for service-based businesses.
Operations and Activities
Operations are a crucial part of a firm's value chain, where value is created through transforming inputs into a finished good or delivering a service. This element is often overlooked in traditional supply chain frameworks, but it's essential for businesses to assess and remedy bottlenecks during this stage.
Technology development, such as research and development, plays a key role in minimizing costs and reducing production, installation, and service times. For instance, Toyota's innovation in just-in-time production revolutionized the auto manufacturing industry by streamlining inventory management.
Human Resource Management (HRM) is also vital in operations, as it enables companies to bring on and train new staff to implement new efficiencies and scale operations. This is especially important for businesses looking to stay competitive and adapt to changing market conditions.
Inbound logistics, operations, outbound logistics, marketing & sales, and service are the five primary activities that directly involve the production and selling of the actual product. Operations are where the factory conveyor belts are being used, transforming inputs into the final product form through activities such as machining, packaging, assembly, equipment maintenance, testing, printing, and facility operations.
Outbound logistics collect, store, and physically distribute the product to buyers through activities such as finished goods warehousing, material handling, delivery vehicle operations, order processing, and scheduling.
Outbound
Outbound logistics is a crucial part of the value chain, responsible for delivering final products or services to the end consumer. It's a process that can be external or internal, and involves the warehousing of products.
The steps in outbound logistics may vary depending on the structure of the business, such as selling directly to consumers, in stores, or in bulk. For example, S’well water bottles sells directly to consumers in stores and in bulk, each type of selling having a different process for outbound logistics.
Outbound logistics is the gate between production and reaching customers, and disruptions in this process can be catastrophic for some product groups, especially perishables that can get ruined and become worthless due to delays.
To limit vulnerabilities to disruptions, businesses can introduce tactics and policies such as securing multiple logistics providers and integrating agile logistics processes to accommodate throttles in production and distribution processes. Integrated ERPs can also help with effective tracking and allocation of inventories and products.
The activities associated with outbound logistics include collecting, storing, and physically distributing the product to buyers, such as finished goods warehousing, material handling, delivery vehicle operations, order processing, and scheduling.
Outbound logistics can either chip away at the company's margin by wholesalers and retailers or retain the majority of it through a direct-to-consumer business model. Disruptions in this process can have significant revenue implications and force consumers to choose substitute products.
Services
Services play a vital role in delivering products, and their significance is on the rise due to the growth of Products-as-a-Service like Peloton or smart thermostats.
These services often include add-on services, warranties, refunds, and returns, which help maintain products and enhance consumer experience.
In today's economy, after-sales service is just as important as promotional activities, and complaints from unsatisfied customers can spread quickly due to the internet.
To maintain customer satisfaction, it's essential to have the right customer service practices in place, including activities like installation, repair, training, parts supply, and product adjustment.
Large firms like Apple have outsourced their trade-in and refurbishing programs to third parties to keep their corporate structures lean.
Companies should budget for servicing and warranties, and allocate proper resources to ensure customer satisfaction and potential referrals that can grow revenue.
Fortunately, firms are largely in control of their service departments, limiting vulnerabilities to disruptions.
Frequently Asked Questions
What is the difference between a firm and industry value chain?
A firm value chain focuses on a single company's activities, while an industry value chain encompasses the entire supply chain of multiple companies within an industry, from raw materials to end consumers. Understanding the difference between these two value chains is crucial for businesses to optimize their operations and stay competitive.
What is firm infrastructure value chain?
Firm infrastructure refers to the organization and leadership structure of a company, which can significantly impact its success and performance. Effective firm infrastructure can lead to remarkable outcomes, such as increased market share and consumer loyalty.
Sources
- https://converged.propelsoftware.com/blogs/the-complete-guide-to-value-chain
- https://quantive.com/resources/articles/value-chain-analysis
- https://strategiccfo.com/articles/management-ownership/value-chain/
- https://parametricpro.com/blog/2021/6/9/the-value-chain-framework
- https://www.business-to-you.com/value-chain/
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