What makes customers place one product in their shopping carts and put another back on the shelf? In the eyes of the customer, the product that made it to the cart likely offered a higher perceived value than the one left behind. Every step of a business’s operation contributes to the value a product offers to customers, and each of those steps is part of the value chain.
By analyzing their value chain, businesses can determine where they might have an edge over their competition and where they may fall short. An analysis of the value chain can help businesses find any deficiencies in their operations, so they can save money and improve the quality of their products to gain the attention of customers. Ultimately, a business with an optimized value chain may create more superior products than its competitors at a lower cost, which can give its products the best chance of ending up in customers’ carts — and allow the company to reap higher profits.
What Is Value Chain Analysis?
Value chain analysis is a way to study every step in the process of creating and distributing goods or services — from the initial design of products to customer delivery. But unlike supply chain analysis, which often focuses on the business’s needs, value chain analysis is framed around what the product — and the customer — stands to gain from each step.
For example, an appliance company may be spending more money per unit during the manufacturing process than its competitor. Through value chain analysis, the business may decide to simplify its production process to cut costs. Or it may determine that its current process is worth the extra expense, since it’s producing a superior product that can be sold at a premium price and is allowing the company to earn higher profits than the competitor earns. Applying that level of analysis to the entire value chain provides businesses with opportunities at every stage of their operations, enabling them to distinguish themselves from the competition — either by differentiating their products or reducing their costs.
The is made up of two types of activities: primary and support. Primary activities are directly involved in the production, sale and distribution of a good or service; they include manufacturing, order fulfillment and marketing. Support activities increase the efficiency of primary activities through operations like evaluating a company’s infrastructure, conducting research and development, procuring raw materials and managing employees. The illustration below shows that these steps all add value for customers.
Key Takeaways
- A company’s value chain includes every step involved in creating, delivering and marketing a product or service.
- Value chain analysis focuses on developing a product or service that is better suited to the customer’s wants and needs than the products and services competing companies are offering.
- By analyzing the value chain, businesses can create advantages over their competitors, either by reducing their costs or differentiating their products.
Value Chain Analysis Explained
Harvard Business School professor Michael E. Porter coined the term “value chain” in his 1985 book, “Competitive Advantage: Creating and Sustaining Superior Performance,” and since then, analyzing the value chain has become an important way for businesses to improve their operations. Porter separated business operations into primary activities and support activities. Each activity can be analyzed and optimized to ensure that value is efficiently being added and waste is being reduced. Businesses using value chain analysis can look at every activity and ask two questions: What value does this step in the process contribute to the final product? Can that value be accomplished more efficiently?
Primary activities are directly involved in producing and selling products and are divided into five categories.
- Inbound logistics. Companies typically need to collect, store and use raw materials to manufacture their products. Receiving, warehousing, inventory control and storage of supplies are considered inbound logistics, which can be analyzed to find ways to cut costs.
- Operations. The processes that take raw materials and turn them into the finished product are known as operations in the value chain. Optimizing the manufacturing process, including the use of labor and machinery, can help businesses fulfill orders in less time and for less money.
- Outbound logistics. After a product is manufactured, it needs to be prepared for order fulfillment. Outbound logistics may include shipping products to retail locations, storing them for ecommerce fulfillment and managing in-store inventory levels. Streamlining this step is important because delays between order placement and the delivery of products could negatively impact the company’s relationship with the customer.
- Marketing and sales. A product has no value to customers unless they are aware of it and can purchase it. Through marketing and sales, a business can show the value of its products to customers and make it available through in-store or website sales.
- Service. Even though final delivery of a product often represents the end of the value chain, some products include post-sale services like returns, warranties and maintenance. These services may add extra value for customers — and, in some cases, generate extra revenue for companies as well. Reverse logistics systems can be used to maintain the value of a product long after the customer has returned an item, often by repairing or recycling the product.
Secondary activities help increase the efficiency of primary activities and are also divided into four categories.
- Company infrastructure. The company’s infrastructure refers to its administrative, management, financial, legal and quality control mechanisms, the structures a business has in place to make key business decisions and manage its resources.
- Technology development. This support activity includes the implementation of technological advancements, such as process automation and machinery upgrades. Technology improvements at various stages, from designing to manufacturing products, often help to reduce costs and increase efficiency and productivity.
- Human resources management. Whether targeted at welcoming new hires, implementing updated training programs or retaining long-term employees, effective human resources management is crucial. A productive and knowledgeable staff can address concerns among employees and ensure that staff members remain happy and productive.
- Procurement. Procurement covers the purchase of raw materials, machinery, office equipment and office space. Proper procurement operations ensure that departments have the resources they need to complete their responsibilities.
Why Is Value Chain Analysis Important?
Value chain analysis helps businesses deliver the most valuable products and services at the least possible cost. Through value chain analysis, businesses can find ways to optimize their processes to keep customers satisfied, thereby maintaining customer loyalty and increasing the likelihood of repeat sales.
Value chain analysis often takes a two-pronged approach: first, finding places where costs can be trimmed, then identifying how products can be improved. If a business can create superior goods that customers are willing to purchase and reduce its costs, it can often gain a competitive advantage and greatly increase its profit margins.