The Value Chain
Tips and tricks to evaluate your industry’s value chain
Overview
Evaluating the value chain is a critical step to understand your position in the market relative to your customers and suppliers (and their customers and suppliers). I use this as part of my market analysis playbook that largely leverages Porter’s Five Forces framework. The Value Chain is helpful in assessing competitive rivalry, the power of suppliers and buyers in the framework illustrated below.
There are a number of great resources that can provide an overview of value chain analysis, below is one that I found that did a good job laying out the process to map the value chain. I’ll focus this post on analyzing the value and the tools that can be useful to add data to your value chain.
The Approach
I’ll assume that you have figured out the value chain for your industry. This can also be done internally focused, but that is generally easier to evaluate as you control the data. For an external analysis there are a few data sources I look for:
- Margins / Revenues for each segment
- Economic value add
- Descriptive stats on each segment
Through the example below I’ll layout a few of the data sources I use. I personally like this ‘detective’ type of work to figure out the details of a market. My advice is to move fast and don’t dwell too much on any of the data. Here is my tactical approach of how I work to get data and structure a market analysis.
The first pass
The first pass should be very rapid and focused on collecting a set of sources. Through this first pass you should be able to identify 50–70% of the total data you’ll need. This is hard data in tables that will be easy to analyze (e.g. Census Data). Move fast to download lots of data files / links that seem relevant, ideally you have some good sense of where to start with the data. Once you have scoured a good pass on the data you should start to analyze the data and pull out findings.
The second pass
Now that you have a somewhat structured picture of the data it is time for the the second pass. At this stage I am focused on targeted searches where I’m looking for specific data points through articles and PR updates. This data can fill gaps, add context, and help you to find other sources. After you get through this pass it is time to evaluate what you have. You’ll still have gaps. At this point I like to fill gaps with assumptions and clearly note my assumptions.
Going deeper
The best place to figure out your holes is to get a peer review at this point. Depending on the questions that come up it may be worth going deeper. Normally I find the two pass model gets me in the right ballpark for high level analyses to inform a decision. I then leave going deeper for modifications in the future that is more ad-hoc. For example, if I hear a podcast or read an article that is relevant I’ll look to add it to the data or as part of a quarterly process (e.g. evaluating industry earnings).
These three steps set you up to get a strong analysis of the market.
Example — Windows
I recently completed a market analysis for one of the home services verticals, window installation. For those not familiar with how a window is made, I have laid out the flow below
Assess the value for each step
This can be challenging to get to this data. For my analysis I started with the American Housing Survey done by the US Census department. I find that the Census has a lot of very useful data to start with getting market figures. For my analysis I used the following:
- Producer Price Index
- EIOLCA tool from CMU
- Bureau of Labor Statistics on Employment
- US Census data on # of companies and payroll
This data allowed me to understand how many companies at each step of the process and the size of the companies.
Next I went to IBIS World. The previews for an industry can give you some of the data to correlate a take on the market. There are often many industry research providers that will post some detail on the market you are interested to help triangulate on the value of the market. Along with the revenues I reference NYU Stern’s post on margin profiles for various industries to get a sense for the type of businesses and the margin control they have.
The graphic below is an illustrative slice looking at a few of the components from the diagram above. In my full analysis I looked at all of the various elements to better understand the dynamics. Note of caution this is where you could end up in some serious rabbit holes to find the perfect data. You likely won’t get all of the data you want and will need to make assumptions.
Basic Analysis
A few things that stand out to me from the above:
- There must be other paths to market for many of the products that are created. For example, if Logging generates $16bn in revenue and Wood Products does $7bn, where does the other $9bn in revenue go?
- Window Assembly companies are much larger in size than other areas of the value chain. This includes companies like Pella, Anderson, and Jeld-Wen that capture a large percent of the market. In going deeper on the data this is because of the high costs to produce and distribute the products
- Building Materials Stores generate more revenue than the rest of the value chain combined. If you’ve ever been to a Lowe’s you know they sell thousands of products and Windows is one category. To go one level deeper you can see through Lowe’s 10K that Windows is not a major segment of their product sales, but part of their ~$5bn services business.
This data shows the size of the various industries that make up the value chain, but lacks the breakdown of the value creation. I use the producer price index (PPI), especially using the EIOLCA tool from CMU, to understand the value creation by component of the value chain.
The graph above shows the value distribution to produce the product. Clearly from the data the most value comes from the final assembly.
In Closing
It can take time to get your value chain defined the first time, but this can then be a valuable tool to evaluate changes in the market. Value chain analysis can be helpful in determining your strategy to grow your share of the market, whether that be to vertically integrate in your industry or offer additional products / services. Another strong use case is to evaluate the pressure you can assert or expect from suppliers and customers.
A couple examples:
- A new provider enters the market, let’s say Google or Amazon. You can use the value chain and look at their financials to evaluate why they entered this space and the likelihood of their success.
- Evaluating a pricing change. If you are a large % of your customer’s input costs and you are one of a few suppliers you should expect they will evaluate other providers.
The basis of a value chain helps to layout the dynamics of an industry and template to evaluate market changes. For your specific industry you’ll get more specific on calling out the largest providers. I like to use the tool to evaluate longer term strategies and quarterly looks at how the market is changing.
References
Margins by industry… http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/margin.html
BLS Producer Price Index has details on the amount of economic value… https://www.bls.gov/ppi/
EIOLCA tool is helpful to understand the amount value from different aspects of the value chain… http://www.eiolca.net/
