Competitive Advantage

3.2.1 Value Chain Analysis

To understand which activities provide a business with a

competitive advantage, either through cost advantage or product differentiation, it is helpful to separate operations into a series of value-generating activities referred to as “the value chain”

1. Background

Value Chain Analysis is a concept that was first described and popularised by Michael Porter in his 1985 book, Competitive Advantage.

2. Relevance

In order to understand the activities that provide a business with a competitive advantage, either through cost advantage or product

differentiation, it is useful to separate the business operation into a series of value-generating activities referred to as “the value chain”.

Value Chain Analysis involves identifying all of the important activities in which a business engages and then determining which ones give the company a defensible competitive advantage. By doing this, a company can:

1. Determine which activities are best undertaken internally and which ones are able to be outsourced or eliminated;

2. Identify and compare strengths and weaknesses with the competition; and

3. Identify synergies between activities.

3. Value Chain Analysis Explained

Michael Porter introduced a generic value chain model that comprises a sequence of activities common to a wide range of firms. Porter

suggested that the activities of a business could be grouped under two headings:

1. Primary activities: Those that are directly concerned with creating and delivering a product or service; and

2. Support activities: Those that are not directly involved in production, but may increase efficiency or effectiveness.

Figure 3: The Generic Value Chain

The firm’s margin or profit depends on its ability to perform these activities efficiently, so that the amount that the customer is willing to pay for the products exceeds the cost of the activities in the value chain.

3.1. Primary activities

The primary value chain activities include:

1. Inbound Logistics: Receiving and storing externally sourced materials;

2. Operations: Manufacturing; the way in which inputs are converted into final products;

3. Outbound Logistics: Inventory storage and distribution to customers;

4. Marketing & Sales: Identification of customer needs and preferences, marketing strategy and sales generation;

5. Service: Supporting customers after the product or service has been sold to them.

3.2. Support activities

The support value chain activities include:

1. Human resource management: Recruitment, training,

development, motivation and compensation of employees;

2. Infrastructure: Includes a broad range of support systems

including organisational structure, planning, management, quality control, culture, and finance;

3. Procurement: Sourcing resources and negotiating with suppliers;

and

4. Technology development: Managing information, developing and protecting new products and services, developing more efficient processes, and improving quality.

4. Application of the Value Chain Analysis 4.1 Steps to take

Value Chain Analysis can be undertaken by following three (3) steps:

1. Break down a company into its key activities under each of the headings in the model;

2. Identify activities that contribute to the firm’s competitive

advantage either by giving it a cost advantage or creating product differentiation. At the same time, also identify activities where the business appears to be at a competitive disadvantage; and

3. Develop strategies around the activities that provide a sustainable competitive advantage.

4.2 Cost advantage

A business can achieve a cost advantage over its competitors by

understanding the costs associated with each activity and then organising each activity so that it is as efficient as possible.

Porter identified ten (10) cost drivers related to each activity in the value chain:

1. 4.3 Economies of Scale;

2. Learning;

3. Capacity utilisation;

4. Linkages among activities;

5. Interrelationships among business units;

6. Degree of vertical integration;

7. Timing of market entry;

8. Firm’s policy on targeting cost or product differentiation;

9. Geographic location;

10. Institutional factors (regulation, union activity, taxes, etc.).

A firm can develop a cost advantage by controlling these ten (10) cost drivers better than its competitors.

A cost advantage can also be pursued by reconfiguring the value chain.

Reconfiguration means introducing structural changes such as a new production process, new distribution channels, or a different sales

approach. For example, Qantas structurally redefined its maintenance of aircraft, traditionally conducted by in-house engineers, by outsourcing this function to private overseas contractors.

4.3. Product differentiation

A firm can achieve product differentiation by focusing on its core competencies in order to perform them better than its competitors.

Product differentiation can be achieved through any part of the value chain. For example, procurement of inputs that are unique and not

widely available to competitors, providing high levels of product support services, or designing innovative and aesthetically attractive products.

5. Issues arising from Value Chain Analysis 5.1. Linkages between value generating activities

Value chain activities are not isolated from one another. Rather, one value chain activity often affects the cost or performance of other value chain activities. Linkages may exist between primary activities and also between primary and support activities.

For example, the design of a product might be changed in order to reduce manufacturing costs. However, if the new product design inadvertently results in increased service costs then the total cost reduction could be less than anticipated.

5.2. Business unit interrelationships

Business unit interrelationships can be identified using the Value Chain Analysis.

Business unit interrelationships offer opportunities to create synergies among business units. For example, if multiple business units require the same raw material and the procurement process can be coordinated then bulk purchasing may result in cost reductions. Such interrelationships may exist simultaneously in multiple value chain activities.

5.3. Outsourcing

Value Chain Analysis can help management decide which activities to outsource. It is rare for a business to undertake all primary and support activities internally. In order to decide which activities to outsource managers must understand the firm’s strengths and weaknesses, both in terms of cost and ability to differentiate.

6. Case Example

Below we consider some of the issues that might be relevant for some of Coca Cola’s value chain activities:

1. Procurement: Is it more cost effective to procure inputs locally, regionally or globally? If local procurement is more expensive but better for the environment and local communities, can this be used as a point of differentiation? Are there likely to be political or

environmental disturbances that could drive up the cost of key inputs like corn syrup or aluminium?

2. Operations: How much does a bottling plant cost to build and run? How often do factories need to be re-engineered? Would it be more cost effective to outsource bottling? Is bottling

strategically important for product differentiation?

3. Logistics: What is the cost of inventory storage? How is Coca Cola distributed to customers? How many cans are lost in transit?

4. Marketing & Sales: Are consumer preferences changing over time? Will people enjoy cherry cola? Are people becoming more health conscious?