A Value Chain Analysis is a powerful tool for businesses, allowing them to focus on those activities that deliver value to customers.
The concept entered the business world in 1985 in business management consultant Michael Porter's book, Competitive Advantage: Creating and Sustaining Superior Performance. The model helps enterprises see the value chain as a collection of activities that a company performs to create value for its customers. Delivering a higher level of value leads to a competitive advantage and higher profitability for the organization.
The process breaks down an organization's activities into strategically relevant pieces so that managers can build a full picture of cost drivers and sources of differentiation and identify areas of improvement.
The results can be used to guide investment of resources and identify processes that could be outsourced or eliminated. Our goal in this article is to provide value chain analysis examples for different industries that could be applied to any organization.
How to Create a Value Chain Analysis
The objective for a value chain analysis is to create or strengthen a business's competitive advantage. The process includes looking at five primary and four secondary activities and assigning a value to those activities. Then look for sub-activities for each of the main activities: direct, indirect and quality assurance.
Based on the enterprise strategy, the analysis will focus either on cost advantage or differentiation advantage.
Identify the connections between the activities. Human resources, for example, can play a significant role in production staffing levels, training the sales force and customer service satisfaction. Finding ways to shorten the value chain — this distance between activities and the customer — will help an enterprise meet evolving customer needs in order to deliver greater value to the customer.
For even small companies, creating a value chain analysis can be a complicated process. However, the results can help guide strategic thinking to improve the profitability of the business.
Retail Value Chain Analysis
Tesco PLC is a large retail grocery chain with nearly 8,000 locations in 11 countries. Research Methodology conducted a value chain analysis on the retail giant and found that it creates values through cost leadership and availability. In other words, it promotes low prices and operates stores in four formats, from small Express shops to large Superstores. The company also manufactures its own private label goods. The private label goods are designed to compete against other stores that focus on low cost as a differentiator.
The research found that with Tesco's focus on low cost, it's difficult for the company to provide a high level of customer service. The cost reduction focus reduces the company's willingness to invest in staffing levels, training and customer service technology.
By contrast, the Nordstrom retail chain has chosen a service differentiation strategy, although in recent years it is developed lower-cost affiliated stores like Nordstrom Rack to bring value to the budget conscious shopper and compete in demographic areas where the full-line stores would not be successful. An analysis completed by researchers at the University of Denver revealed that Nordstrom views the typical support activity of human resources as a service differentiator.
In recent years the company has modified its generous return policy to reign in abuse, but it is still more customer friendly than many of its competitors. Nordstrom empowers its employees with a simple policy: Use your best judgment in all situations. The company expects the employee to be creative in serving customers, and customers are willing to pay premium prices in exchange. The company invests in training and empowering personal shoppers to create relationships with frequent customers and has invested in technology to support those interactions.
By looking at two extremes in the value chain, a retailer can develop an understanding of their own strategy and how it relates to customers. The ultimate goal of conducting a value chain analysis is to focus on delivering value to customers in a way that positions the company as a leader.
Service Value Chain Analysis
For service industries, the value chain consists of different inputs and outputs than retail or manufacturing. Characteristics of a service business can include:
- Inseparability: The service is delivered and consumed simultaneously, e.g., a massage.
- Intangibility: The service can only be experienced by the user, e.g., a golf lesson.
- Perishability: The service cannot be saved or stored, e.g., an airline seat or hotel room.
- Heterogeneity: Variability in the performance of ostensibly the same service, e.g., quality of customer service.
Because services are intangible, value addition must happen with every activity throughout the process. The enterprise can't rely on the value inherent in a product as a retailer or manufacturer would. If a traveler misses a flight or has an unsatisfactory hotel stay, the customer does not highly value the interaction with the company. Similar conditions are inherent in financial services businesses such as insurance and investing. The product is essentially the customer's relationship with the organization.
A value chain analysis of two airlines illustrates the cost vs. service differentiation strategies and how those influence strategic decisions within the company. Southwest has positioned itself as the low-cost carrier, while American Airlines operates on a full-service model, according to research from The Capstone Group. Southwest's value chain is designed to reduce costs, so customers enjoy the differentiation of lower fares. That means there are no seat reservations and the airline flies only one brand of airplane to reduce maintenance costs. American Airlines offers a higher level of service, including seat reservations and operates a variety of aircraft sizes to serve many different market sizes.
To ensure it is able to continue to offer low-cost fair, Southwest took the risky step of buying contracts to purchase jet fuel at a fixed price over a number of years. Rising fuel prices blindsided other airlines and forced them to raise fares. Southwest delivered value to its customers through its procurement activity.
To support its low-cost strategy, Southwest limits the markets to which it flies to those highly probably of filling the type of aircraft it operates. Its primary customer base is the 65 percent of the airline market that flies for leisure travel. American has invested in a global access strategy, offering service on a global basis. Its customer base is a larger share of business travelers who tend to be able to pay higher fares for a higher level of comfort and service.
Since an airline seat is a perishable commodity — like a hair salon appointment or hotel room — the organization must understand the value it offers customers and builds the organization to support it. A thorough analysis can uncover the value that happens at every stage of the customer relationship. When a customer books flight, the airline is doing more than just selling a seat from origin to destination. Each stage, from booking through landing, must add value for the customer. At a basic level, adding value can be as simple as not causing a hassle from a canceled flight or lost luggage. The airline experience is transitory and intangible, so the airline only has one chance to satisfy the customer.
Pharmaceutical Value Chain Analysis
The pharmaceutical value chain is complex, from research & development to manufacturing and retail distribution. Much like a retailer, a pharmaceutical value chain creates value directly for consumers through their products. Wholesalers and distributors fulfill vital roles in delivering products to consumers from the manufacturers. The final step of distribution is often through a retail pharmacy or a healthcare facility. In some cases, consumers don't have much, if any, choice in the provider or the cost of the medication.
In many cases, value chain analysis is undertaken to determine where costs can be reduced while being more consumer-centered. For large retail chains, the drive toward lowers costs has resulted in a move toward deeper involvement in pharmacy benefit management, specialty pharmacies or retail healthcare according to management consulting firm McKinsey & Company. Pharmaceutical companies are looking for ways to deliver additional value to the consumer through higher levels of service. Also, consumers are looking for lower cost ways to purchase prescription medications through mail-order and online services. Many medications such as infusion therapies are delivered at home or in healthcare facilities and consumers have little to no input on the purchase decisions. The value chain may emphasize the systems and relationships necessary to position the product close to the consumer or the healthcare professional that will make the decision to use the product.
A value chain analysis can point the way to profitability for any company regardless of the industry. After all, every company has customers of some type. The goal of the value chain analysis is to align the enterprise with those activities customers value most.
If you have any questions about a value chain analysis or taking your supply chain to the next level, my team and I are here to help. Interested in learning more about value chain analysis? See our article explaining value chain analysis and how to use it to optimize your supply chain.