How to perform a Value Chain Analysis (explained with example)?
I received a lot of great feedback on my blog about how to use Porter’s 5 forces and a few requests to write a post about how the value chain works. So hoping this article will help you understand the basics of the Value Chain and how to analyze the value chain of a company.
What is a Value Chain?
A Value Chain is a set of activities that a firm performs in order to create a product or a service. For companies that produce a product, it involves bringing a product from conception to the final sale and post-sale service and everything in between — such as procuring raw materials, manufacturing, and marketing, etc.
The concept of Value Chain was introduced for the first time by Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and Sustaining Superior Performance.
Below picture shows how the value chain model looks like:
Porter splits a business’s activities into two categories, “Primary” and “Support”. Specific activities in each category will vary according to the industry.
Primary Activities: Primary Activities are essential for adding value and creating a competitive advantage. Below are the five components of primary activities:
a) Inbound Logistics: Functions like receiving, warehousing, and managing inventory.
b) Operations: Procedures for manufacturing products and converting raw materials into finished products.
c) Outbound Logistics: Involves aspects of distribution like fast-delivery and efficient order processing.
d) Marketing & Sales: Strategies to build a brand reputation — such as advertising, promotion, and pricing.
e) Service: Refers to customer service, maintenance, repair, refund, and exchange.
Support Activities: As the name suggests, the role of support activities is to support the primary activities more efficient. Increasing any of the four support activities helps at least one primary activity to work more efficiently. Below are the four support activities as defined by Porter:
a) Procurement: This activity relates to how the company procures its raw materials to manufacture a product.
b) Technological Development: This activity pertains to equipment, manufacturing techniques, software, and technical knowledge to convert the firm’s transformation of inputs into outputs.
c) Human Resources (HR) Management: Consists of aspects involved with hiring and retaining employees who fulfill the firm’s strategy. This also includes training employees to provide excellent customer service.
d) Firm Infrastructure: This activity includes MIS that supports fast response capabilities, and the composition of its management team — such as planning, accounting, finance, and quality control.
Key Considerations for analyzing a Value Chain:
Now that the basic definitions are clarified. Let me walk you through some of the key considerations (or things to remember) when you are analyzing a value chain:
- Value Chain is a way of classifying activities to help you think rigorously about where value is created or destroyed.
- Value Chain is really a model about margins and what contributes to the margins of a business — (a) Is the cost of the final product reduced?, (b) Has the customer’s willingness to pay increased?
Specific Questions to answer when analyzing Value Chain:
The key is to think about how the margin is improved at each step:
- Is the value “created” or “destroyed”? THEN
- Through costs or willingness to pay? THEN
- Is the value created “superior” or “inferior” to its competitors? or equivalent?
Example: Canadian Pacific Railway (CP)
To make this more clear, let us go through an example. Let us say that the Canadian Pacific rail is the firm that we want to analyze. Canadian Pacific Railway (CP) is a Canadian Class 1 railway. Canadian National Rail (CN) is the prime competitor of CP. The point of the example is to walk you through an application of value chain analysis of a business, you don’t need a background of the industry or CP rail to understand the concepts. Below example will demonstrate how to answer the 3 questions mentioned above to analyze the value chain of a business:
Primary Activities:
Inbound Logistics: Inbound logistics activities like the door, terminal, and rail service, create value for CP and lowers its costs. CN provides similar services, however in-house FastPass technology has reduced driver processing time and accelerated CP’s container pickup and delivery time, creating superior value compared to its competitors who have higher inbound processing times.
Operations: CP’s low terminal dwell time decreases the company’s costs, but it performs poorly in other metrics of operational efficiency such as travel time, resulting in increased costs compared to its competitors and destroying value in the process.
Outbound Logistics: CP creates value by providing various freight collection options at its destination points. With the addition of FastPass technology, CP provides superior value to its competitors and lowers costs for the company.
Marketing & Sales: CP’s promotional campaigns, such as CP Canada 150 Train, create value by increasing consumer awareness, engagement and willingness to pay. CP was also lauded as a leader in climate change transparency by the Carbon Disclosure Project. Value created is equivalent to competitors such as CN with its reduce-reuse-recycle and reforestation programs and other green initiatives.
Service: Because of the nature of the operations, customer service creates limited value through dispute resolution, increasing customer’s Willingness to Pay, which is equivalent to competitors.
Support Activities:
Procurement: Cost-efficiency in acquiring engines, railcars, fuel, etc. and managing relationships with vendors creates value and lowers the company’s costs. The value created appears equivalent to competitors.
Technological Development: CP launched a locomotive modernization program, automated gates, and new CP FastPass technology at its terminals in 2017, creating value and lowering the company’s costs. CP creates equivalent value as CN with the “Trip Optimizer” energy management system and UP with its “Genset” locomotives.
Human Resource Management: CP creates value through recruitment, training, negotiating with unions etc., thus lowering CP’s costs. In 2017, CP signed and ratified 7 Bargaining Agreements. It runs programs like the HomeSafe Initiative and Conductor Management Training Program. The value created is equivalent to CN which provides technical training through two campuses and has a joint union-management initiative for safety called “Looking Out For Each Other”.
Firm Infrastructure: General management and planning decisions like the recently launched daily service between Vancouver and Detroit cut transit time by 48 hours. This creates value for CP and effectively lowers company’s costs by reducing fuel consumption for the same journey and increasing customer willingness to pay because of the fast transportation time. CN’s strategic control of the network corridor around the Chicago hub follows a similar strategy, pointing to equivalent value being created in this activity.
The above analysis gives a detailed analysis of how the different primary and secondary value chain activities create/destroy value by impacting the costs and the willingness of the customer to pay and how the value compares to the competition. The analysis can help the firm understand where they can improve value to save costs and have a competitive advantage.
I hope this post will help you understand how to perform a value chain analysis of a particular firm.
