Understanding value chain analysis and how to use it is a valuable skill for any business owner. By pinpointing areas of your business where you can improve efficiency, value chain analysis helps you increase your profit margin.
In this guide, you'll learn how to identify the different activities in your value chain and the steps to performing value chain analysis in your business.
What is a value chain?
A value chain is the series of activities and processes your business uses to turn an idea into a finished product or service. Each step adds value to a product or service, such as by sourcing materials, manufacturing, marketing and delivering to customers.
Don't confuse your value chain with supply chain management, which involves a flow of goods, processes, information and finances from suppliers to the end consumer.
What is value chain analysis?
Value chain analysis involves looking closely at each step in your business to see if you can increase efficiency anywhere. The aim is to improve production efficiency and reduce expenses like cost of sales and operating costs to boost the overall value of your business.
Academic Michael Porter introduced the concept of a value chain in 1985 to identify competitive advantages in business. Though Porter's original intended value chain analysis was to be applied to goods manufacturing companies, his method can be adapted to practically any type of business, including service-based businesses.
Why is value chain analysis important?
Value chain analysis is important because the business landscape is more fast-paced and competitive than ever before. Value chain analysis lets you find areas of weakness in your business so you can optimise your processes to maximise competitive advantage and profitability.
What are primary value chain activities?
Primary value chain activities vary depending on your industry. Still, you should be able to identify activities in your business that fit into the following 3 categories:
1. Operations
Operations include everything you do to turn inputs or materials into a finished product or service. For a product-based business, operations might consist of assembly, packaging, and warehouse management.
If your business is service-based, operations might include coordinating client appointments, managing service delivery, providing ongoing support, and continuously improving service processes to enhance client satisfaction.
2. Inbound/outbound logistics
Inbound logistics and outbound logistics cover all the processes you go through before and after creating your product or service. Inbound logistics include activities like sourcing materials from suppliers to inventory management. Essentially, gathering everything you need to make your product.
Once you've got a finished product ready to go, your outbound logistics are the activities needed to get it to your customer. If you have a product-based business, this will include things like shipping and delivery. In contrast, a service-based business will consist of things like appointment scheduling.
3. Marketing & sales
Marketing and sales activities are vital in value chain analysis. You may need to revisit your marketing plan template if you're not reaching sufficient numbers of people or your target customers.
From a sales perspective, you'll want to ensure you're pricing your products effectively. If you’re already conducting regular sales forecasts, the data from your reports may come in handy.
What are supporting value chain activities?
Supporting value chain activities are the things you do to make your primary activities more efficient. You'll typically add these activities to your income statement as overhead costs, and they can be broken down into the following categories:
Procurement
Procurement covers everything you do to source the materials, equipment, and services you need to deliver your finished product or service. In this step, you'll want to examine your current procurement strategy to see if there’s anything you can streamline to optimise your procurement processes.
Infrastructure
Infrastructure activities generally support your business's entire value chain, encompassing everything from quality control to financial plans and accounting software.
Human resource management
Human resource management, or HR management, includes all activities relating to recruiting, training, and retaining your staff. In this step, you’ll want to look at things like staff turnover, employee benefits, and employee retention strategies.
You should also review your payroll management to see if you can boost efficiency in your compensation processes, perhaps with a cloud payroll system.
Types of value chain analysis
There are two main types of value chain analysis: cost advantage and differentiation advantage. The two are similar in looking at what sets your business apart from your competition.
The difference between the two types lies in your end goal: Are you performing a value chain analysis because you want to be more affordable or have better margins than your competitors, or do you want to offer a better product or service?
Let's look at the two types of value chain analysis in more detail:
Cost advantage
The cost advantage strategy focuses on increasing profit margins or making pricing more competitive. To achieve this strategy, you'll need to reduce costs in as many activities in your value chain as possible.
For example, if you manufacture sportswear, you might investigate how to source cheaper materials or improve efficiency on the production lines. This will decrease cost-per-unit, allowing you to improve your profit margins or lower retail prices.
Differentiation advantage
The differentiation advantage (or specialisation advantage) strategy helps you create a better product or service than your rivals.
Let's use the sportswear example again. Rather than cutting costs, you can use the differentiation advantage to see how you can improve the final product. If you sell sportswear, this might include sourcing more breathable materials or adding features to the products, like pockets or personalisation options. This sets your product apart from your competition, and your customers may be willing to spend a little extra.
How to perform value chain analysis
To perform a value chain analysis, start with these 3 steps:
1. Identify value chain activities
Identify your value chain activities by listing all the processes that go into creating your product or service. If you offer several products or services, you’ll need to go through this process for each one.
2. Determine activities' values and costs
Determining the activities' values and costs is the next step. Look at each activity and determine how much it costs your business compared to how much value it adds to the final product.
3. Identify competitive advantage opportunities
How you identify competitive advantage opportunities depends on whether you’re aiming for a cost advantage or a differentiation advantage.
If you're looking to price yourself more competitively, consider whether you can reduce the costs of your more expensive activities, especially if they add little value to the process.
To beat your competitors on quality, look for activities where you could add more value. If you find an activity that adds value but costs you little, consider investing more time and resources there.
Examples of value chain analysis
Here's an example of value chain analysis. Imagine your business sells candles online and in a few homeware stores. Let's look at your value chain activities and how you could use it to reduce costs or increase value:
Primary activities
Operations
You make the candles by hand. If this process were more efficient, you could create more products faster by creating candles in bulk on an assembly line.
Your packaging is also costly, so it's a good idea to get quotes from other suppliers and see if a simpler packaging design would lower the cost, too.
Inbound logistics
You buy wax and fragrances in small quantities. To cut costs, ask suppliers for discounts on bulk orders. Note this might impact the cost of storing inventory, which is another inbound logistic activity to consider.
Outbound logistics
Your main outbound logistic activity is product delivery. For online orders, you deliver products to your customers through couriers and the mail. You personally deliver bulk orders to local retailers, but this takes a lot of time and fuel costs are very high.
You could switch to a local transportation company to make the deliveries, which will initially be an extra overhead cost. However, it may be worth it if you can complete deliveries more quickly, supply to more retailers, and save time.
Marketing & sales
You mainly advertise in local print magazines. Evaluate the number of people seeing the advert per dollar spent and consider whether other publications with similar advertising rates reach more of your target customers.
Supporting activities
Procurement
You have sourced wax from the same supplier for years, but your supplier has recently raised their prices. Speak to the supplier to see if they would offer a discount for customer loyalty. If they refuse, look for alternative suppliers providing the same materials for lower prices.
Infrastructure
All online orders go through your ecommerce website and incur monthly hosting and maintenance fees. If you're not locked into a long-term contract with your current provider, look into alternative ecommerce software providers who offer cheaper hosting services or more features for the same price.
Once you make a sale on your website, you manually process and fulfil the order yourself. This is a very time-consuming process, so looking at an order management system to automate some of these admin tasks would be a good idea.
Human resource management
You’re currently the only staff member. If you hired an employee, you could delegate some of the day-to-day responsibilities, giving you more time to invest in market research, product development, and sales and marketing activities.
Value chain analysis FAQs
What are the benefits of value chain analysis?
The benefits of value chain analysis include reduced overhead costs and business expenses, more efficient processes, and improved profitability.
What are the limitations of value chain analysis?
A key limitation of value chain analysis is that it was initially created for product-based businesses. This means it can be more challenging to apply it to service-based businesses. In this scenario, it might be more profitable for you to focus on customer experience management strategies instead.
Another drawback of value chain analysis is that when focusing on the fine details of your processes, you can lose sight of how they interact. For example, you may see a costly, low-value activity in your value chain as an area of weakness in your business.
However, it could be vital preparation for another activity that adds significant value. By ignoring the connections between activities, you risk focusing your optimisation efforts on the wrong areas.
What is value chain risk?
Value chain risk refers to an event's likelihood and impact on your activities. For example, a risk in your value chain is poor weather affecting material availability. When performing a value chain analysis, consider any risks affecting each activity and how to mitigate them.
Find the weak links, extract more value
Gathering all the facts and figures for value chain analysis can seem like a daunting task, but it's well worth the effort. When you're running a business, every second is valuable. Having data on hand with a business management platform like MYOB makes this process much faster. Check out our plans and pricing and get started with MYOB today!
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