VALUE CHAIN
Abstract
Firms respond to conditions in their marketplaces by modifying their competencies such as internal capabilities and linkages with suppliers and associates and the ways in which they position themselves in relation to their competitors specifically their strategic direction ( 1999; 1990). Each of these components is intricately related and ultimately contributes to firm competitive advantage.
Most organizations support the consumption of products and services by consumers. Hence, understanding the value chains involved in producing these products and services is the best approach to building the value of the enterprise. Effective organizations align their structure to their value chain. An enterprise needs, at the very least, to define its role in the value chains based on its unique mix of strengths and weaknesses and design its processes, supporting assets and organizational structure and decision making.
(1990) argues that firms create value for their customers by establishing a value chain within the organization. When customers recognize these values as being superior to the firm’s competitors, the firm has established competitive advantage within its marketplace. Porter describes two broad ways in which firms can deliver this value: lower cost and differentiation. A lower cost emphasis is one where the firm can provide a good or service more efficiently than either the client or other competing firms; a differentiation emphasis is one where firms create superior value in the form of product or service quality.
The Value Chain: Nature and Background
To better understand the activities through which a firm develops a competitive advantage and creates shareholder value, it is useful to separate the business system into a series of value–generating activities referred to as the value chain. According to (2000), a value chain is “a string of companies working together to satisfy market demands.” The value chain typically consists of one or a few primary value (product or service) suppliers and many other suppliers that add on to the value that is ultimately presented to the buying public.
In his 1985 book Competitive Advantage, Michael E. Porter introduced a generic value chain model that comprises a sequence of activities found to be common to a wide range of firms. Porter identified the primary and support activities as depicted in Figure 1.
Fig. 1: The Value Chain Activities
Primary Activities
The goal of these activities is to create value that exceeds the cost of providing the product or service, thus generating a profit.
The primary value chain activities are the following:
- Inbounds logistics include the receiving, warehousing and inventory control of input materials and transportation scheduling.
- Operations are the value–creating activities that transform the inputs into the final product. It includes machining, packaging, assembly, equipment maintenance, testing and all other value-creating activities that transform the inputs into the final product.
- Outbound logistics are the activities required to get the finished product to the customer, including warehousing, order fulfillment and distribution management, etc.
- Marketing and Sales are those activities associated with getting buyers to purchase the product including channel selection, advertising, promotion, selling, pricing, retail management, etc.
- Service activities are those that maintain and enhance the product’s value including customer support, repair services, etc.
Essentially, any or all of these primary services may be vital in developing a competitive advantage. For example, logistic activities are critical for a provider of distribution services, and service activities may be the key focus for a firm offering on – site maintenance contracts for office equipments.
These five categories are generic and portrayed here in a general manner. Each generic activity includes specific activities that, of course, vary by industry.
Support Activities
The primary chain activities described above are facilitated by support activities. Porter subsequently identified four generic categories of support activities, the details of which are industry–specific, to wit:
- Procurement – the function of purchasing the raw materials, spare parts, buildings, machines and other inputs used in the value–creating activities.
- Technology Department – includes research and development, process automation, design and redesign, and other technology development used to support the value–chain activities.
- Human Resource Management – the activities associated with recruiting, development and compensation of employees.
- Firm Infrastructure – includes activities such as finance, legal, quality management, etc.
Support activities often are viewed as overhead, but some firms successfully have used them to develop a competitive advantage, for example, to develop a cost advantage through innovative management of information systems.
Value Chain Analysis and Core Competencies
In order to better understand the activities leading to a competitive advantage, one can begin with the generic value chain and then identify the relevant firm–specific activities. Thereby, process flows can be mapped, and these flows used to isolate the individual value–creating activities.
Once the discreet activities are defined, linkages between activities should be identified (1986). A linkage exists if the performance or cost of one activity affects that of another. Competitive advantage may be obtained by optimizing and coordinating linked activities.
Value-chain analysis looks at every step a business goes through, from raw materials to the eventual end-user. The goal is to deliver maximum value for the least possible total cost. The value chain also is useful in outsourcing decisions. Understanding the linkages between activities can lead to more optimal make–or–buy decisions that can result in either a cost advantage or a differentiation advantage.
Furthermore, value chain framework describes the activities within and around an organization, and relates them to an analysis of the competitive strength of the organization ( 1995). Therefore, it evaluates which value each particular activity adds to the organizations products or services. This idea was built upon the insight that an organization is more than a random compilation of machinery, equipment, people and money. Only if these things are arranged into systems and systematic activates it will become possible to produce something for which customers are willing to pay a price ( 2001). Porter argues that the ability to perform particular activities and to manage the linkages between these activities is a source of competitive advantage.
Application of the concept of value chain generates insights concerning how firms compete against other firms, how value is created, and whether or not firms can expect to maintain a current competitive advantage. The basic premise is that competitive advantage stems from, and is understood by, examining the many discrete activities a firm performs in support of its products.
Examining a firm’s value chain sheds light on how the firm competes (cost, differentiation, or focus strategy), the basis for this competitive advantage, the relative strength of the competitive advantage, and whether the current advantage is sustainable (1991).
The competitive scope of a firm is likewise important in creating competitive advantage. Broad scope, for example, may allow a firm to exploit interrelationships between the value chains that serve a number of different product or buyer segments, geographic areas or related industries, while narrow scope can allow the tailoring of its chain to serve a particular target segment, geographic area or industry, resulting in lower costs or differentiation compared to competitors. This relationship between competitive scope and the value chain therefore provides the basis for defining more relevant business unit boundaries and allows a firm to establish organizational structure more in line with its sources of competitive advantage.
To sum it up, effective and efficient practice of this process must be driven by the companies overall strategy. The capabilities and grid characteristics of the utility, as well as the density and demographics of the company’s potential customer base should likewise be studied and considered for evaluation.
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