A simple and comprehensive guide to value chain analysis
January 07, 2022
One of the first challenges you face as a burgeoning entrepreneur is finding a market that isn’t saturated with clone businesses. Diving in and competing with established companies is tough, especially if you haven’t figured out how to differentiate your business. So, what should you do? Well, if you don’t want to be among the 95% of businesses that fail each year (eek!), a good place to start is with a value chain analysis.
What is a value chain analysis?
A long list of factors goes into creating a product or service: raw materials, labor, logistics, management, marketing — and so on. All the activities that contribute to the development of a product or service from start to finish are known as the value chain. And a value chain analysis is the process of measuring how much value a business is creating in order to optimize it.
Visualizing value-add processes in a diagram is a smart way to understand your business’s competitive advantage. It can also provide a framework for eliminating inefficient activities, speeding up production, and lowering the cost of creating value. Basically, a value chain analysis helps you find the sweet spot between offering your customers great value and bringing in a good profit for those services or products.
What is a competitive advantage?
Competitive advantage is any factor that puts you ahead of the competition. These factors could range from location or supplier relationships to venture capital and branding. When several factors work to your advantage, they combine to give the business a big step up in the market.
Building a competitive advantage is about thinking strategically. For instance, businesses can leverage financial opportunities and market conditions that are less accessible to competitors. First, decide which leadership strategy your business will follow to improve your competitive advantage.
1. Cost advantage
Cost advantage is about offering the lowest possible price for your customers. A cost-advantage model requires extreme efficiency to maintain a high profit margin. Organizations that prefer this model use the minimum amount of resources and work with cheaper materials to control business costs.
Cost leadership examples include McDonald’s, Dollar General, Walmart, and IKEA.
2. Differentiation advantage
A differentiation strategy is more difficult because it involves providing a niche product or benefit that isn’t easy for competitors to replicate. Strong differentiation means putting a lot of effort into innovation, research, and the protection of intellectual property. Once you have that unique product, brand, or service, though, you can charge a premium.
Differentiation leadership examples include Dyson, Maserati, Vitamix, and Apple.
Once you choose a strategy, you’ll need to conduct some in-depth market research so you can gain a full picture of your competitors and their offerings. Then, you can work out where the opportunity lies and move on to optimizing your value chain.
What to include in your value chain
From the minuscule to the mighty, most organizations have hundreds — if not thousands — of business activities. So to simplify things, American academic and value chain godfather Michael Porter suggests we split it into two groups: primary activities and support activities. He created this diagram to illustrate his point:
Primary activities are tasks related to creating and distributing the product or service. The five primary activities include:
- Inbound logistics: the journey of materials or resources from the supplier to your business
- Operations: the method of processing the materials or resources
- Outbound logistics: the method of distribution once the product or service is finished
- Marketing and sales: how the product or service is promoted and sold to your target audience
- Services: the support you offer the customer, including training, guarantees, and post-sale care
Support activities include everything that helps the business carry out its primary activities and gain a competitive advantage. They include the following:
- Infrastructure: the financial and legal support your company needs to make sound business decisions. Having a strong infrastructure in place also protects you from potential issues that could damage your business reputation.
- Human resource management: the process of hiring, training, and managing staff. A motivated workforce with low turnover is vital for businesses that provide in-person services, such as bars, hotels, and airlines.
- Technology development: technology can improve service and decrease production costs, which increases competitive advantage at various stages of the value chain.
- Procurement: how the business acquires resources through suppliers. The goal is to balance quality and cost.
What’s the link between primary and support activities?
It’s important to remember that support activities are just as important as primary activities.
As businesses become more innovative and markets more competitive, support activities increasingly provide a valuable source of differentiation advantage. After all, factors such as technical innovation and HR management strengthen brand loyalty and organizational health. Over time, these factors have a compounding effect that can boost a business’s ability to navigate external issues.
And primary activities, especially those based around materials and logistics, can provide a substantial cost advantage. The key is to see everything as a whole and consistently optimize different parts of the value chain to align with your broader business objectives.
How to analyze and improve the value chain
Value chain analysis should be a recurring process in your business. Markets evolve, and when breakout competitors emerge, it’s crucial to keep evaluating how you stack up in your industry. Follow these steps to assess your business value and refine your operations.
1. Evaluate the cost of primary and support activities
Organize your value chain activities into the two categories we discussed. To fully understand operating costs, you must consider how much each activity contributes to your business value. Assess the activity in terms of how it supports your competitive advantage. Use the questions below as a guide.
- What does it cost your company to perform each activity, especially compared to your top competitors?
- How much does your business depend on each activity to operate smoothly?
- How much does each activity increase value or satisfaction for customers?
- To what degree does end-user satisfaction increase your bottom line?
2. Look for relationships between activities
Think about how one activity might rely on another. For instance, the health of your entire business depends on infrastructure. Without careful financial planning, your company isn’t positioned to grow, pursue the best supplier relationships, or hire top-notch staff.
Look for ways to create a chain reaction of cost reduction. Let’s say you have the option to cut material costs by buying a larger volume and changing your payment cycle. Improving your infrastructure could give you the financial flexibility to leverage this advantage, and ultimately, derive more profit.
3. Identify sources of customer and employee value
One benefit of a differentiation model is that customers and staff become your brand ambassadors. While these companies spend more upfront on production and service, the time they devote to nurturing clients leads to much higher profits. Let’s look at one of the differentiation-advantaged businesses we mentioned earlier: Vitamix.
Vitamix high-performance blenders cost roughly 10x more than the average blender. The company can charge a premium because the brand is known for its high-powered blades that effortlessly break down various foods. The company also offers an exceptional full-coverage warranty, inspiring confidence in customers.
As a result, Vitamix benefits from a high volume of word-of-mouth marketing. Not only do people directly recommend these products to friends, but social media influencers regularly create content using the products. So, if you can find a way to leverage the value of your customers or staff, don’t overlook how lucrative it can be.
4. Find opportunities to boost competitive advantage
Building on the previous step, explore the rest of your value chain to find cost-cutting (or profit-generating) opportunities. Keep the following questions in mind:
- What elements can you add to your business to significantly increase value? Extra features? Complementary services? Quality guarantees? Customization? Bundled subscriptions? Better onboarding?
- How can you work with suppliers, manufacturers, or distributors to deliver a higher-quality product to end users?
- What company-wide changes can you make to provide better service to customers?
- Are there activities in the value chain you can completely manage in-house to improve quality?
- Do you need to restructure your business model to be more sustainable in your industry?
These are just a few questions to consider. Use your analysis to decide which activities to investigate in more detail.
If you’re struggling to conduct a VCA, you could be misidentifying your competitive advantage. Some businesses are not competitive enough on cost but also lack the differentiation to sustain consistent profits. This is a common problem in the restaurant industry, in which markets are heavily saturated.
In this case, it’s essential to go back to basics with a value proposition statement and SWOT analysis outlining what you offer as a business.
When running a value chain analysis, creating a visual diagram helps you see how everything relates.
Porter’s value chain analysis is an excellent place to start when creating a general overview of your business activities. But it’s not the end: you can adapt and modify the basic value chain for all kinds of business activities, including profit margin analysis and merger and acquisition transition analysis.
Use dedicated diagramming software to take the stress out of designing your diagram. Rather than struggling with weird formatting, just grab a template, edit it with custom shapes, and share it with your team.
Plus, if you’re using Cacoo — our own diagramming tool — you can store your value chain analysis and other diagrams in the cloud, collaborate on them with your team in real-time, and share or export your results with ease. All of this means you can create and optimize your value chain analysis quickly and easily.
This post was originally published on May 10, 2019, and updated most recently on January 7, 2022.