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The big picture
According to Porter (1985), competitive advantage can only be understood by looking at the firm as a whole. Cost advantages and successful differentiation are found by considering the chain of activities a firm performs to deliver value to its customers.
Support activities
Primary activities
Firm infrastructure
Human resource management Technological development Procurement
Margin
Inbound logistics Operations Outbound logistics Marketing and sales Service
Margin
Figure 16.1 Value chain analysis
The value chain model divides the generic value-adding activities of an organisation into primary and secondary activities. An advantage or disadvantage can occur within any of the five primary or four secondary activities. Together, these activities constitute the value chain of any firm.
When to use it
The model can be used to examine the development of competitive advantage. By identifying the potential value to the company of separate activities, a firm can gain insight into how to maximise value creation while minimising costs, and hence create a competitive advantage.
The value chain is also useful for outsourcing and off-shoring decisions (see also p.38). A better understanding of the links between activities can lead to better make-or-buy decisions that can result in either a cost or a differentiation advantage.
How to use it
In order to analyse the competitive advantage (or lack of one), Porter suggests using the value chain to separate the company’s activities in the value chain into detailed discrete activities. The relative performance of the company can be deter-mined once the firm’s activities have been broken down to a sufficient level of detail.
Porter has identified a set of generic activities. The primary activities include inbound logistics, operations, outbound logistics, marketing and sales, and serv-ices. The support activities include procurement, technology development, human resource management and the firm’s infrastructure. Each activity should be analysed for its added value. Also the total combined value of all these activities when considered in relation to the costs of providing the product or service has to be analysed, since this will dictate the level (or lack) of profit margin.
l Inbound logistics– activities include receiving, storing, listing and grouping inputs to the product. It also includes functions such as materials handling, warehousing, inventory management, transportation scheduling and managing suppliers.
l Operations– include machining, packaging, assembly, maintenance of equipment, testing and operational management.
l Outbound logistics– refers to activities such as order processing, warehousing, scheduling transportation and distribution management.
l Marketing and sales– includes all activities that make or convince buyers to purchase the company’s products. Included are: advertising, promotion, selling, pricing, channel selection and retail management.
l Service– is concerned with maintaining the product after sale, thus
guaranteeing quality and/or adding value in other ways, such as installation, training, servicing, providing spare parts and upgrading. Service enhances the product value and allows for after-sale (commercial) interaction with the buyer.
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l Procurement– is referred to by Porter as a secondary activity, although many purchasing gurus would argue that it is (at least partly) a primary activity. Included are activities such as purchasing raw materials, servicing, supplies, negotiating contracts with suppliers, securing building leases, and so on.
l Technology development– Porter refers to activities such as R&D, product and/or process improvements, (re)design and developing new services.
l Human resource management – includes recruitment and education, as well as compensation, employee retention and other means of capitalising on human resources.
l Infrastructure– such as general management, planning procedures, finance, accounting, public affairs and quality management, can make the difference between success and (despite the best intentions in the world) failure.
Final analysis
Since Porter introduced the value chain model in the mid-1980s, strategic planners and consultants have used it extensively to map out a company’s strengths and shortcomings. When strategic alliances, and merger and acquisition (M&A) deals are analysed, the value chain is used frequently to gain a quick overview of a poss-ible match. For example, if one company is strong in logistics, and the other in sales and service, together they would make an agile, highly commercial competitor.
There is one downside: it is difficult to measure or rate competitive strengths objectively. Especially when trying to map the entire value chain and apply quanti-tative measurements or ratings, many companies find themselves employing large numbers of strategic analysts, planners and consultants.
The term value grid has recently been introduced. This term highlights the fact that competition in the value chain has been shifting away from the strict view defined by the traditional value chain model (Pil and Holweg, 2006).
References
Pil, F.K. and M. Holweg (2006) ‘Evolving from value chain to value grid’. MIT Sloan Management Review 47 (4): 72–9.
Porter, M.E. (1985) Competitive Advantage: Creating and sustaining superior per-formance. New York: Free Press.
THE VALUE CHAIN 73 A visualisation of the company or a competitor
The company
A quick and dirty identification of (lack of) strengths
+ direct logistics system + dedicated sales force etc.
Comparison of competitive strengths
versus
Analysis to establish potential match for M&A or strategic alliances There are various ways in which we have seen consultants use the value chain. Take your pick from the following.
Figure 16.2 The value chain: a versatile tool for consultants
The big picture
Value-based management (VBM) is a tool for maximising the value of a corporation.
VBM uses valuation techniques for performance management, business control and decision-making. The value of a company is determined according to its dis-counted future cash flows. Value is created when a company invests capital against returns that exceed the capital cost. All strategies and decisions are tested against potential value creation. There are several ways of using VBM. The simplest is the use of VBM for financial reporting. The earnings will be subjected to a capital charge (economic value added). VBM can also be used for capital budgeting and invest-ment analysis. All investinvest-ments are tested against the required capital charge.
Properly executed, this approach aligns all activities and decision-making on the key drivers of value.
When to use it
Value-based management is used to set goals, evaluate performance, determine bonuses and communicate with investors, as well as for capital budgeting and val-uations. Traditional accounting systems determine the value of organisations based on performance measurements such as earnings per share and return on equity.
However, they take no account of the effectiveness with which resources are deployed and managed, i.e. the cost of the opportunity to invest capital. As a result, many companies that appear profitable on paper are, in fact, considerably less so.
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