Many companies use analytics to evaluate and improve their business practices. While there are many industry-specific measurement tools out there, some are useful across all sectors. One of them is value chain analysis.
In this article, we explain what a value chain is, highlight the elements that are included in a chain, explain the steps required to review this analysis, offer an analysis example, and provide the difference between a value chain and a supply chain.
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What is Value Chain?
A value chain is a comprehensive description of the value of a product or service from product conception to delivery to customers. It is the process by which a company creates value for its customers.
Often, companies measure the success of their value chains by profit margins. Using the profit margin formula, businesses can see exactly how much value they add from product conception to completion.
Usually, more added value means more profit for the company. Profit margin is the value created minus the costs of creating value.
Economic theorist and academic Michael Porter coined the term “value chain” in his 1985 book “ Competitive Advantage. Since he described the value chain in the text, the business community has used the concept extensively. Any industry or company can use value chain analysis because it is a generic model and is highly adaptable.
Even within a single company, different departments can customize the model as needed to meet their goals. Many industries use this analysis and are doing it increasingly for global value chain studies.
Part of the Value Chain
Porter’s value chain has clear and specific elements that are broken down into two categories. The analysis prioritizes systems over departments because the ultimate goal of value chain analysis is to identify aspects of a system or process for improvement rather than entire departments.
The value chain identifies the general business activities and areas of assistance in which they function in two broad categories called primary and support:
Main
The main category of the value chain has five subcategories:
- Inbound logistics: This process deals with internal logistics such as storing, receiving and distributing spare parts or materials. Suppliers are usually a key factor in the inbound logistics process.
- Operations: These processes contribute to the shift from raw input materials to final, customer-ready outputs. Process operations are usually internal.
- Outbound logistics: This process includes the steps that supply products to customers from your company. Sometimes, this involves an external shipping connection whereas for other companies outbound logistics it is an internal procedure.
- Marketing and sales: This process deals with persuading customers to make a purchase from your company. Most companies have in-house sales and marketing teams.
- Service: This process includes any post-purchase or support actions your company takes to maximize customer happiness and loyalty.
Supporter
Within the category of value chain support, Porter identified four important areas:
- Enterprise infrastructure: These are activities that support the creation of a product or service, but do not have to contribute directly. Accounting, management and law are examples of corporate infrastructure.
- Human resource management: This activity includes everything related to employees or other workers involved in all steps of the value chain.
- Technology development: This activity includes all the technological processes and procedures that your company uses as part of the value chain.
- Procurement: This activity includes every step your business takes to purchase the raw materials needed to make your product.
How to Use Value Chain
To apply value chain analysis to your company and find areas for growth and improvement, follow these steps:
1. Define the necessary procedures for each main activity
Begin by identifying the procedures required for each major activity. For example, a furniture maker would list their process for getting their materials under inbound logistics and their delivery process under outbound logistics.
Do this for each of the five categories: inbound logistics, operations, outbound logistics, marketing and sales and service.
2. Identify the procedures required for each support activity
Define all processes required for the support activity that apply to the main activity. For example, a furniture maker would list under the company infrastructure subcategory how the company’s accounting department procedures support inbound logistics, operations, outbound logistics, and so on.
Do this for all support activities in company infrastructure, human resource management, technology development, and procurement.
3. Analyze each process for possible improvements
Once you have defined each process in your value chain, analyze each for possible improvements. See where you can streamline processes, remove unnecessary steps, or restructure communications to increase the efficiency and value of procedures. Do this for each process.
4. Find productive solutions
Now that you have identified areas for improvement, find realistic solutions that you can apply to the process. Select a few areas to tackle with concrete solutions and set up a tracking system to compare metrics after deployment.
5. Apply findings
Apply the solution you choose to your process. Track related metrics to see how your customizations are increasing the value of your product and your overall value chain.
Difference between Value Chain and Supply Chain
While value chains and supply chains have overlapping qualities and elements, there are some important key differences. The supply chain tracks the creation of the product and its directly related efforts, while the value chain tracks every element of the company to measure the added value.
The supply chain is primarily external, while the value chain is primarily internal. The supply chain focuses on identifying the physical parts and materials that go into a product while the value chain measures all elements of the supply chain apart from the related processes in marketing, advertising, design, and research and development.