Translating an inspired idea into a robust business plan
010 The Value Chain
The concept of the value chain developed by Michael Porter,, is used in most businesses. Managing the value chain can produce competitive advantage and increase returns. While it may appear a little dated in its original form, the concept is valid and is a useful tool to analyse a business.
A principal use of value chain analysis is to identify a strategy mismatch between different elements of the value chain. If a company competes on the basis of low costs, then every part of the value chain should be geared towards low cost. For example, low-cost airlines have looked at every aspect of the value chain and taken out costs at all stages. Bookings are taken only via the internet rather than through travel agents; seats cannot be reserved; there are no paper tickets, free meals and drinks, or lounges; and flights depart from secondary airports with lower landing fees.
The value is also useful in conjunction value add analysis, i.e. how much value is added by the different activities that go into the final product. A particular activity may have lower return on capital employed than the average return on capital employed for the company as a whole. For example, a manufacturing business has a return on average capital employed (ROACE) of 18%. Part of its operation is a chain of retail outlets. The ROACE from retailing is only 10%. The business could decide to withdraw from retailing and sell off the shops, thus releasing capital and generating a higher ROACE for the remaining business.
As regards using the value chain analysis for cost reduction, it may be possible identify vertical activities that can be outsourced rather than produced in-house. Some major retailers decided that specialist logistics companies could transport goods to stores more efficiently. The value chain can also be used to examine whether a product should be made or bought in.
The value chain as described by Porter has its limitations and should not be used slavishly. Your business may have a different value chain. For example, a trading business may just buy and sell and never handle any physical goods. Porterís value chain provides a framework for analysis that can be adapted to your particular business.
The value chain is a useful tool for strategic analysis of your firm, helping you to think about the structure of your business and to identify in which business activities your company really competes in, i.e. what are the value chain activities. It may allow you to rethink your business or, to use a modern term, re-engineer your business and thus increase margins.