NAARM

PGDM-721-4

Value Chain Analysis

NH Rao

Nov 2013

PGDM (Agriculture)

NAARMLearning Objectives

• Review of concepts – value creation, strategy, five forces

• Strategy and the value chain

• value chain analysis

• example

NAARMReview: value creation and capture

• Total value created = (B - S) = difference between customers’ willingness-to-pay for a product and the suppliers’ opportunity costs of supplying the inputs for that product

• To capture value a firm must wedge between customer willingness to pay and supplier opportunity cost

• competition closes the wedge (P-C)

= minimum price supplier would accept to supply a resource

A firm creates value when the network of customers and suppliers are all better off with it than without it

NAARMReview: Competitive Strategy – core concepts

• Business Strategy: theory of how an organization faced with competition will achieve sustainably superior performance in a dynamic business environment

• applicable at the level of a business unit/product

• sustainably superior performance = superior long-term profitability > industry average

= firm has competitive advantage

• competitive advantage: depends on firm’s ability to create and capture unique value

• Porter: creating unique mix of value by choosing a path different from others, not beating rivals, is at the heart of competitive strategy (companies compete to be unique to deliver superior value to chosen consumers)

• Delivering unique value :

• defining a company’s long-term position in the marketplace

• making the hard trade-offs about what the company will and will not do to provide value to customers, and

• forging hard-to-replicate fit among parts of the “activity system” of the firm (value chain) to deliver value to customers

Business/industry environment governs choice of strategic position, tradeoffs and activity fit

NAARMReview: Business environment

Fig source: Thomson, et al, 2009

• External environment – macro: demographic, economic, technological, societal, policies, legal (not in company’s control)

• external environment – micro - industry environment: competitors, suppliers, customers

• Internal environment: firm’s resources, operational processes- core competence

Tools for analyzing business environment

• Macro environment- Environmental Analysis, scenario planning (long term disruptive changes)

• Integration of macro, and internal environments: SWOT

• Micro environment - Porter’s five forces analysis

NAARMPorter’s Five Forces Model of Industry CompetitionPorter’s Five Forces Model of Industry Competition

• Companies compete for profits – not beat rivals

• competition is rooted in industry structure

• industry structure is governed by five forces

• Five Forces determine average profitability of industry

• Companies compete for profits within an industry structure

• Competitive advantage: long term profits > industry average

Profitability can be reduced by:

• Buyers: powerful buyers can force

prices down or demand more value

from a product

• Suppliers: powerful suppliers will

demand higher prices or more

favourable terms

• Substitutes: that meet the same basic

need as the industry’s product in a

different way – depends on buyers

choice to substitute alternate

products

• Rivals: if rivalry is intense companies

compete away the value they create –

passing it to buyers or sellers or to

higher costs of competing

• New entrants: similar to rivals; threat

of entry – not necessarily actual entry,

can reduce product prices

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Positioning - Three generic choices

• Positioning: based on industry analysis consistent with vision, mission, value systems

• Operational effectiveness: performing similar activities better than rivals for lower costs

• Competitive advantage: achieving unique and hard to copy fit among policies, structures, resources, activities, skills, behaviours, management systems, etc. to deliver unique value – requires tradeoffs

Strategic positioning

Productivity frontier (maximum value that can be created at a given cost– highest OE)

operational effectiveness(internal focus)

Review: both operational effectiveness and positioning are important for competitive advantage

Figs adapted from : Porter, 2012

(external / customer focus)

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Example: specialty foods

• Natural, fresh, organic, and prepared foods and health items with excellent service at premium prices

• Cater to specialized nutritional requirements (diabetics, allergies, etc.)

• Educated, middle class, and affluent customers who are passionate about food and a healthy lifestyle

Strategic Positioning - value proposition

Value preposition has an external focus - customers or demand size of business

• First test of a firm’s strategy: whether value proposition is different from that of rivals

• If the firm is serving the same customers, meeting the same needs and selling at the same relative price – the firm has no strategy

• each value proposition is best served by a tailored value chain

NAARMValue Chain

• Value chain: sequence of activities that an organization carries out to design, produce sell, deliver and support its products (create and capture value)

• Activities: discrete economic functions or processes (developing products, managing a supply chain,, delivery to customers) that involve a mix of resources (people, technology, assets, capital, information, etc.)

• Activities govern costs and prices

• Competitive advantage arises from choice of activities in the value chain of the firm

• Value chain perspective: each activity is not only a cost but adds incremental value to the product or service

most value chain activities are interlinked, and dependant upon the others

the firm is a part of a larger value system – beyond the firm’s boundaries (suppliers, customers, etc)

competitive advantage cannot be achieved by considering single activities independently - it is attained based upon complex linkages between activities

• Value chain analysis: analyzing the value contributed by each of the activities that comprise a company’s internal operations, in making a product or service go from raw materials to a finished good or service

NAARMFive Forces and Value Chain Analysis : superior performance (profitability)

Industry structure Relative position in Industry

Porters’ Framework

Five Forces Value chain

Focus of Analysis Drivers of industry profitability

Differences in activities

What the analysis does

Industry average price and cost(profitability)

Relative price (positioning)Relative cost (value chain)

(profitability = spread between the two)

• Strategy: shifts relative price and relative cost in company’s favour for higher profits

• Competitive advantage: superior performance from higher prices, lower costs or both

• Sources of value (price or cost differences): activities that companies perform

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general-purpose framework for value chain analysis - disaggregates a firm into strategically relevant activities to explore sources of competitive advantage - activities thet result in higher price or lower cost

Porter’s Value Chain Framework

• Two types of activities:

• primary

• Support / secondary

• how value chain activities are performed determines costs and affects profits

• cost of one activity is affected by the way other activities are performed

• focus on systems – not on individual department costs

• all competitive advantage resides in the activities of the value chain

• strategy - achieving a low cost of differentiation though unique activities by making choices about how activities in the value chain are configured and linked together to deliver unique value

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Primary Activities create the product or service, deliver it to the market, create a demand for the product, and provide after-sale support.

• Inbound logistics: processes related to receiving, storing, and distributing inputs internally - supplier relationships are key to creating value

• Operations: transformation activities that change inputs into outputs that are sold to customers - operational systems create value.

• Outbound logistics: activities through which product or service is delivered to customers - collection, storage, and distribution systems (internal or external to the organization) create value.

• Marketing and sales: processes to persuade customers to purchase from the firm instead of its competitors - benefits offered, and how these are communicated are sources of value.

• Service: activities related to maintaining the value of product or service to customers, once it's been purchased – efficiency and quality of service are sources if value

Primary Activities

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Support Activities provide the input and infrastructure that allow the primary activities to take place.

• Procurement (purchasing): finding vendors and negotiating best prices

• Human resource management: how well a company recruits, hires, trains, motivates, rewards, and retains its workers. People are a significant source of value and firms can create value with good HR practices

• Technological development: includes managing and processing information, protecting the company's knowledge base - minimizing information technology costs, staying current with technological advances, and maintaining technical excellence are sources of value creation

• Infrastructure: firm's support systems and functions that allow it to maintain daily operations - accounting, legal, administrative, and general management are necessary infrastructure that businesses use to create value

Support Activities

NAARMSteps in value chain analysis (for a business unit)

1. Layout the industry value chain – sequence of activities and sub-activities for creating value (essentially its current business model)

Source: Magretta, 2011

• identify

• upstream and downstream ends of the value chain

• boundaries for each segment

• key value creating activities at each segment

2. Compare with the firm’s value chain with industry value chain

3. Identify where the profit performance comes from:

i. Identify price drivers (differentiation analysis) – activities that impact differentiation/buyer value – product design, production process, selling experience, customer support; Compare with industry rivals

ii. Identify cost drivers (cost analysis) – particularly high relative cost activities; Compare with industry rivals

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4. identify links: connections between all value activities identified

5. identify unique activities that increase value at each link – cost strategy, differentiation strategy

6. align all the above with firm’s strategy and prioritize

Value chain analysis will enable:

• seeing a business as collection of value creating activities – seeing each activity not just as cost but as step to add some increment of value to finished product/service

• seeing beyond the organization to integrate with the larger system

• identifying possible synergies among various units of an organization

• determining which value activities are best outsourced and which core competencies are best developed internally.

• assessing where there may be potential to remove a step in the process that adds little value

• uncovering where a company is weak and is thus vulnerable.

Steps in value chain analysis

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• A unique value proposition different from rivals

• A distinctive value chain tailored to the value proposition

• Making clear tradeoffs, and choosing what not to do

• Choices across the value chain that fit together and reinforce each other

• Strategic continuity, with continual improvement in realizing the strategy

The five tests of good strategy:

NAARMExample: McDonald’s

Strategic Value proposition: High quality products, served quickly and with a smile, in a clean and pleasant environment, and all at a fair price

• Cost – economies of scale, cost controls

• Quality – consistent, universal, core offerings, healthy

• Speed - 90 sec service, hot and fresh, daily availability

• Flexibility – size, packaging, variety, drive through

• service - with a smile

NAARMMcD’s value Chain (contd..)

Firm Infrastructure, HR, Technology, procurement: • Brand recognition; #1 in retail fast food industry; Leadership; • Financial Strength; Company image; Intellectual property; Franchising; largest employer in US; company image (?); Culture insensitivities (?); law suits (?)

Inbound logistics• Economies of scale – Pass value to

customer• Just-in-time order &

delivery• Sustainable

packaging - Renewable

resources (Packaging

composition 82% renewable resources)

• Supply chain control• Quality control – Freight truck

inspections – Random audits

operations• On-line & on-site

kiosk job application systems

• Reinforced information systems - Wireless headsets

- Wi-Fi offered in all locations

• R&D in target consumer demands and trends

• Corporate guidelines imposed on franchisees

• Franchisees must purchase supplies from McD’s

• 90 sec drive through rule

outbound logistics• Distributor

agreements• Quality control – Freight truck

inspections – random audits• Refrigerated trucks• Reinforced

Information Systems

– Cashier – Assembly Line – Order fulfillment• Just in time order &

delivery – Ensures freshness• Packaging quality

reinforces freshness – Hot/Warm food

Marketing and sales• Product – Health product offerings – Consumer research• Price – McValue Menu – Party pack• Promotion – cartoon

affiliations (Disney and Nickelodeon)

– Coca-Cola endorsement – Olympic sponsorship Place – McD’s goes “green” – McCafe – Wi-Fi – McD’s Play Place• Community outreach• Adaptation to global

culture and customs (?)

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Service

Fast food service

• Order accuracy

• Clean environment

• Friendly customer service

McD’s value Chain (contd..) and competitive advantage

Sources of competitive advantage and market ledership

• operations: activity fit that supports a strategy for production and delivery of affordable food to a large number of customers:

• low cost,

• high speed

• consistent quality

• convenience

• firm infrastructure:

• strong financial resources

• brand image

• supplier relations

• franchisee base

NAARMSecondary Applications of VCA

• Competitor analysis

• Customer value analysis

• Determining company scope

• Strategic cost management

• Integration

• Supply chain management

• Strategic outsourcing

• Acquisitions, mergers, strategic alliances

• Organizational structure

• Global strategy

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Thank You