Creating a Competitive Advantage with Value Chain Analysis

 

By Omodiaogbe Samuel

Last Updated: December 8, 2023

Introduction

Value Chain Analysis is a strategic management framework used to analyze an organization to identify the activities that add value to the final product or service, and then determine the activities that help the organization to create a competitive advantage. The value chain model was developed by Michael Porter of Harvard Business School and it provides a systematic way of examining all the organizations internal activities and shows how they interact in an attempt to create a competitive advantage. A company gains competitive advantage by performing strategically important activities more cheaply or better than its competitors. The value chain concept says that there is a chain of events which occur in a company right from the procurement of raw materials to the delivery of goods as well as the post sales services. The value chain is therefore classified into nine activities which are interrelated to one another. While primary activities include the activities that are performed to satisfy external demand, secondary activities are those which are performed to satisfy internal requirements. The key aim of carrying out a Value Chain Analysis is to help the business create a competitive advantage. According to Porter, there are three basic types of competitive advantage an organization can gain; Cost Leadership, Differentiation, and Focus. Since its introduction, the use of value chains and value chain analysis has been extended to various applications beyond the study of individual firms. Value chain analysis has been employed to examine and evaluate entire industries and industry clusters, as well as specific systems within firms.

                                       Step-By-Step Approach to Developing the Value Chain

Step 1: Identify Your Value Activities and Sub-Activities

 

A firm’s operations consist of both primary and support activities done to produce goods and services. This step involves identifying and disjoining each activity to acquire a thorough knowledge of the company’s processes and work done in certain ways to create and deliver valuable products and services to customers

 

When defining sub-activities for the primary activities, bear in mind that there are three types of sub-activities, and they may fall into:

  • Direct activities: Direct activities are activities that create value by themselves
  • Indirect activities: any activities that support your direct activities and allow them to run smoothly
  • Quality assurance: these activities ensure that the direct and indirect activities meet all necessary and required standards.

Step 2: Analyze the Cost of Your Activities

When you have listed of all the business activities out, then you need to work with your team to brainstorm on ways you can create value for your customers as well as your business. When doing this, consider the costs of carrying out each activity, so you can determine if they are cost-effective – if not, you can identify them as an area that needs improvement. To complete this step, you need to assign an individual price within the total cost of the product to each activity. Your most expensive activities need to be addressed first to determine their relative importance to the overall process and if they are improvable.

Step 3: Recognize cost drivers for each activity

Calculate the cost of each activity and the value that it is adding for the business and/or customer. Once you identified and understood these cost driving factors, you can work on improving them to keep costs low. The idea is to determine a business cost driver, and to minimize those costs so you can offer your products and services at more competitive rates. Examples of cost drivers are: labor costs, number of machine hours used, number of units produced, number of product returns from customers, etc.

Step 4: Identify links between these activities

Point out the connections between the activities that you have identified. Changing something for one activity might result in a ripple effect, leading to changes in other activities. These changes can be positive or negative. For example, lowering costs for one activity can lead to other cost reductions, but it can also have the reverse outcome. Getting to know the interconnectivity of activities can help you make the most informed decisions about how to minimize costs

 

Step 5: Look for Opportunities to Gain Additional Value

The Value Chain Analysis you created should be able to show you which activities are actively bringing value for your customers and overall business, as well as being the most cost-effective. You can decide on new ways to do things if an activity costs more than it should, or you might decide to eliminate that activity altogether if it’s not important to the overall production process. You can then use this information derived from the analysis to devise a strategy to improve your business processes and ensure that every action your organization takes is generating results. The overarching goal of conducting the analysis is to create a competitive advantage

 

                                                  Components of the value chain

Primary Activities

The first part is the primary activities which include the five main activities. All five activities are directly involved in the production and selling of the actual product. They cover the physical creation of the product, its sales, transfer to the buyer as well as after sale assistance. The five primary activities are:

Inbound Logistics: This refers to all the activities related to receiving, storing, and distributing inputs (raw materials and resources) internally. Inbound logistics covers everything from material handling, storing products in the warehouse, scheduling vehicles for the transport of materials/products, and returns to suppliers.

Operations: This refers to the process in which raw materials and resources are transformed into the final product or service. Operations comprise packaging, machining, testing, equipment maintenance, assembly, and other activities associated with transforming inputs into the ultimate products. Once the required materials have been collected internally, operations can convert the inputs into the desired product. The activities associated with operations are therefore transforming inputs into the final product form.

Outbound Logistics: This process involves the distribution of a finished product or service. The products or services can be delivered directly to customers or through a network of dealers, distributors, or retailers. After the final product is finished, it still needs to find its way to the customer. Depending on how lean the company is, the product can be shipped right away or has to be stored for a while. The activities associated with outbound logistics are collecting, storing and physically distributing the product to buyers.

 

Marketing & Sales: Just because a product or service exists doesn’t mean customers will automatically buy them. Marketing and sales activities make customers aware of the offering and compel them to make a purchase decision. Marketing and sales describe all the activities your organization uses to influence customers to buy from your organization instead of your competitor. It is the job of marketers and sales executives to make sure that potential customers are aware of the product and are seriously considering purchasing them. Activities associated with marketing and sales are therefore to provide a means by which buyers can purchase the product and induce them to do so. These activities include advertising, sales promotion, public relations, personal selling, salesforce, selection of distribution channel, pricing of products, and other activities related to providing a means by which customers can buy the products.

Service: Service means services provided to the customer in order to improve or maintain the value of the product. In today’s economy, after-sales service is just as important as promotional activities. Complaints from unsatisfied customers are easily spread and shared due to the internet, and the consequences on your company’s reputation might be severe. It is therefore important to have the right customer service practices in place. The activities associated with this part of the value chain is providing service to enhance or maintain the value of the product after it has been sold and delivered. These activities include ancillary solutions such as training, support, guarantees, and warranties, which enhance the product or service experience for customers.

 

Support Activities

Support activities directly support the primary activities and help them to create additional value over your competitors. They assist the primary activities in ensuring that your organization achieves a competitive advantage over competitors. Support activities include: 

 

Procurement: This activity serves the organization by supplying all the necessary inputs like material, machinery or other consumable items required by the organization for performing primary activities. Purchased inputs are needed for every value activity, including support activities. Procurement is therefore needed to assist multiple value chain activities, not just inbound logistics. The goal of procurement is to find quality supplies for production that fit into the organization’s budget. Therefore, procurement activities include finding vendors, negotiating prices, and securing contracts for goods and services needed for production.

 

Technology Development: These activities involve the acquisition and application of technology in the firm. Technology can be used across all value chain activities to improve efficiency and reduce costs, helping to give the business a competitive advantage. Essentially, every value activity embodies technology, be it know-how, procedures or technology embodied in process equipment. The array of technology used in most companies is very broad. Technology development activities can be grouped into efforts to improve the product and the process. Examples are telecommunication technology, accounting automation software, product design research, customer servicing procedures etc. Typically, Research & Development (R&D) department can also be classified here.

Human Resource Management: The right people in the right place can make all the difference for the company, hence the HRM is a support activity that is very important for the firm. Human resource management refers to how your organization recruits, hires, motivates, rewards, and retains its employees. It also encompasses overseeing the selection, promotion, transfer, appraisal and dismissal of staff. HRM impacts the competitive advantage of any firm through its role in determining the skills and motivation of employees and the cost of hiring and training them. Your organization has to recruit, train, and develop the right people for it to be successful

Infrastructure: This refers to the functions and systems that support the company’s ability to maintain operations. It’s a management system which provides services to the whole organization and it includes planning, finance, information management, quality control, legal, government affairs, etc.  The organization’s infrastructure is everything else that goes into creating a product or service that is not directly connected to the final product. The infrastructure shouldn’t be underestimated since it could be one of the most powerful sources of competitive advantage.

                                                        Generic Strategies

According to Michael Porter, there three approaches to generic strategies, and they can be applied to products or services in all industries, and to organizations of all sizes. Porter called the generic strategies―cost leadership, differentiation, and focus strategies

Cost Leadership Strategy

Cost Leadership is a type of competitive strategy with which a company aggressively seeks efficient large-scale production, cost cutting, use of economies of scale, and experience curve to create efficiency better than competition. Firms pursuing this type of strategy are usually more efficient in engineering tasks, production operations, and physical distribution. Cost leadership firms are focused on a large market, and therefore they are more efficient in minimizing costs in marketing and production. This strategy is particularly effective for organizations in industries where there is limited possibility of product differentiation and where buyers are very price sensitive. The goal of cost leadership is to be the low-cost producer in the industry. A low-cost position also means that a company can undercut competitors’ and can still offer comparable quality, and make some profits.

 

Overall, cost leadership is not without potential problems. Two or more firms competing for cost leadership may engage in price wars that drive profits to very low levels. Ideally, a firm using a cost-leader strategy will develop an advantage that others cannot easily copy. Cost leaders also must maintain their investment in state-of-the-art equipment or face the possible entry of more cost-effective competitors

When using the cost advantage analysis, you perform the following five steps:

  • Identify primary and support activities: A firm’s operations consist of both primary and support activities done to produce goods and services. This step involves identifying and disjoining each activity to acquire a thorough knowledge of the company’s processes and work done in certain ways to create and deliver valuable products and services to clients
  • Breakdown costs of each activity within the total cost of the product: This stage of the analysis can help rank each activity based on cost. To complete this step, there is need to assign an individual price within the total cost of the product to each activity. The most expensive activities need to be addressed first to determine their relative importance to the overall process
  • Recognize cost drivers for each activity: Cost drivers cause changes in the cost of an activity. Once you identify and understand these driving factors, you can work on improving them to keep costs low. The idea is to determine a business’ causes of overhead to minimize those costs so you can offer your products and services at more competitive rates.
  • Find links between activities: Changing something from one activity to another might result in a ripple effect leading to changes in other activities. These changes can be positive or negative. Getting to know the interconnectivity of activities can help you make the most informed decisions about how to minimize cost
  • Work on reducing costs: After identifying the ineffective activities and cost drivers, you can create a plan to improve them. You can decide on new ways to do things if an activity cost more than it should, or you might decide to eliminate that activity altogether if it’s not important to the overall production process. You can also choose to change an activity linked to the higher-cost activity if it will have a positive effect

Differentiation Strategy

Differentiation is a type of competitive strategy with which a company seeks to distinguish its products or services from that of competitors. Because this type of strategy involves a unique product, price is not the significant factor. In fact, consumers may be willing to pay a high price for a product that they perceive as different. The product difference may be based on product design, method of distribution, or any aspect of the product (other than price) that is significant to a broad group of consumers. A company choosing this strategy must develop and maintain a product perceived as different enough from the competitors’ products to warrant the asking price.

A differentiation strategy can reduce rivalry with competitors if buyers are loyal to a company’s brand. Companies with a differentiation strategy therefore rely largely on customer loyalty. Because of the uniqueness, companies with this type of strategy usually price their products higher than competitors. Several studies have shown that a differentiation strategy is more likely to generate higher profits than a cost-leadership strategy, because differentiation creates stronger entry barriers. However, a cost-leadership strategy is more likely to generate increases in market share.

 

There are several ways an organization can create a differentiation-based competitive advantage for a single product or the company as a whole. Here are some steps to create a differentiation strategy:

  • Decide what you want to be known for: You must have an idea of your expertise in your business. You’ll need to evaluate what is important to you and your business and the areas your organization succeeds in. You need to know the strengths and weaknesses of your overall brand or specific products.
  • Research your target audience: Research will help you align your business’ offerings with the needs of current and potential customers. This will also inform your selection of differentiators to make your offering more appealing
  • Develop differentiators: Here you need find things that make your brand or products different. Each differentiator may be broad at first, and so you may need to narrow them down by creating smaller subsections. Here are some common differentiations: price, image or reputation, relationships, service, product, distribution, etc.
  • Tell your story: When you tell your business’s unique story, it will assist your differentiation strategy since your competitors are likely not to have same story as yours. Evaluate your mission, vision and values, and you’ll be able to craft an overall story about what sets you apart, which turns your target audience into customers.
  • Create a brand image: Implement your strategy and create a brand image by ensuring better quality. Try to be creative and rebrand if necessary, to capture new clients and customers within your target audience.

Focus Strategy

Focus is a type of competitive strategy that emphasizes concentration on a specific regional market or buyer group: a niche. The company will either use a differentiation or cost leadership strategy, but only for a narrow target market rather than offering it industry-wide. The company first selects a segment or group of segments in an industry and then tailors its strategy to serve those segments best to the exclusion of others. Essentially, the focus strategy has two variants: cost focus and differentiation-focus. These two strategies differ only from Differentiation and Cost Leadership in terms of their competitive scope

 

  • Cost-focus: A cost-focus strategy is a low-cost, that narrowly focused on a market. Firms employing this strategy may focus on a particular buyer segment or a particular geographic segment and must locate a niche market that wants or needs an efficient product and is willing to forgo extras to pay a lower price for the product
  • Differentiation-focus: A differentiation-focus strategy is the marketing of a differentiated product to a narrow market, often involving a unique product and a unique market. This strategy is viable for a company that can convince consumers that its narrow focus allows it to provide better goods and services than its competitors.

Linkages within the Value Chain

Although value activities are the building blocks of competitive advantage, the value chain is not a collection of independent activities. Rather, it is a system of interdependent activities that are related by linkages within the value chain. Decisions made in one value activity (e.g., procurement) may affect another value activity (e.g., operations). Since procurement has the responsibility over the quality of the purchased inputs, it will probably affect the production costs (operations), inspections costs (operations) and eventually even the product quality. Also, though primary activities add value directly to the production process, that doesn’t necessarily mean that they are more important than support activities. Clear communication between and coordination across value chain activities are therefore just as important as the activities themselves. Consequently, a company also needs to optimize these linkages in order to achieve competitive advantage. However, these interconnected activities may be subtle and go unrecognized by the management and therefore lead to missing out on great improvement opportunities.

 

Value chain is not static. It requires constant attention, evaluation, and updating to ensure smooth business progress. You have to ensure that your value chain is constantly updated to adapt to new realities. Your value chain has to keep pace with evolving technology, adapt to the changing workforce, and expand with the global economy. Also, a value chain also requires you to identify so many other direct and indirect activities that can impact your value chain and its performance. This is a huge task, especially when you have to keep track of all of them. 

 

Having understood the conceptual and the analytical framework of the value chain, the next step in to apply in to an organization. Such application would enable us to digest the key components, as well as make strategic decision on how to use the model to create a competitive advantage, by focusing a single strategic direction among the generic strategies

Case Study: Okoroh Fast Food

Okoroh Fast Food is a fast-food restaurant chain located in Nigeria. The company has been in existence for two years and has expended to three locations in Lagos, Nigeria. The plan in to establish 15 other locations in Lagos in the next three years, and then expand to 10 major cities of the country in the next five year. Okoroh Fast Food was setup to redefine fast food industry in Nigeria. As a result, our focus is on the middle-income earners who believe in quality and healthy meal. We offer traditional meals such as pounded yam, eba, and various kinds on local soup. We also offer staple diets such as various kinds of rice, snacks, chicken, fish, and beverages. At Okoroh Fast Food, we’re very mindful of the hearth concerns of our customers, and therefore, we prepare our meals with organic materials and local ingredient. However, we don’t compromise the standard of the tasty meal that makes us to standout in the marketplace

In Nigeria, there are various types of food services business, and they all cater for the needs of different segments of the market. There are those that focus on the bottom of the pyramid (which are usually located on the roadside), the low-income, the lower-middle income, the upper middle income, and the high-income restaurants. Mindful of the different market segments, our focus is on the middle income (lower and upper) who believe in quality and heathy meal, but maybe too busy to make them at home. We understand how busy our customers could be, and therefore we enjoin them to focus on their work or business, while we take care of their meals. Our restaurants are open 16 hours/day to meet the needs of customers who wants to have their meals as early as 6am, and those that close late at 10pm. We also offer takeaway, as well as office/home delivery. We offer excellent services that no other competitor can match. That is coupled with our differentiated approach of sourcing fresh, organic, and local ingredient that makes us unique in the marketplace.

The goal of Okoroh Fast Food is to create a sustainable competitive advantage in the restaurant industry in Nigeria. For us to achieve our goal, we need to conduct analysis on our operations in order to have a deep understanding of how we fare. Also, we need to analyze the industry to know how the competitors are performing on the various value activities. Therefore, for us to conduct the analysis of our operations, and the industry, we have decided to use the Value Chain Analysis. Value chain analysis refers to the process in which an organization identifies the activities that add value to its final product or service and then analyses these activities to see how the organization can create a competitive advantage for itself. Gaining and sustaining competitive advantage depends upon understanding not only a firm’s value chain, but how the firm fits in the overall value system. Therefore, the value chain analysis would help Okoroh Fast Food to increase production proficiency, innovate on the cost driver, and capitalize on the unique capabilities to create a competitive edge

 

                                  Value Chain Analysis of Okoroh Fast Food

                                       Okoroh Fast Food Value Chain Analysis

For us to determine our competitive advantage, we don’t do it in isolation. We need to first of all determine our strengths and capabilities. Secondly, we need to make a comparison with our closest competitors. Remember, on the case study, there are different market segments. There are those that focus on the bottom of the pyramid, the low-income, the lower-middle income, the upper middle income, and the high-income restaurants. Our segment happens to be on the lower and upper middle market segment. Among this segment, we equally need to focus on those that provide the kind of services we offer. As a result, we have identified Ewu restaurant, Eko Quick Food, Climax Foods, and Edo Fast Food as our closest competitors. After identifying the competitors, we decided to conduct research in order to have insight on their value chain model. By understanding their value chain, that puts us in a better position to make comparison. We need to put our value chain vis-à-vis with competition to know how we’re faring. First of all, the outcome would help us to innovate on our model for competitiveness. Secondly, it would help use to use the insights to leverage on our strengths and capabilities to create a competitive advantage.

 

Creating a competitive advantage refers us to the generic strategies―cost leadership, differentiation, and focus strategies.  From the case study, it was clear that Okoroh Fast Food was pursuing differentiation strategy by using key words like “uniqueness” and “standing out” in the market place. However, to create a competitive advantage, there is need to conduct a competitive analysis by understanding the value chain of the close competitions. Such analysis would help Okoroh Fast Food to figure out the strategies of the competitors, as well as enabling it to innovate with the value chain. As a result, giving the understanding of the strengths and weaknesses of the competitors, it would be able to set its own strategic direction. Competitive advantage is not only about strengths or capabilities. Competitive advantage only come from what a company can do better than every other competitor. Therefore, we need to figure out the activities we perform better than others. Also, we need to determine how to strengthen our weaknesses to put us in a better position. Those are the puzzles that the value chain analysis helps us to provide answers to. Therefore, insights from the analysis would help us to continue to improve on our strengths, while at the same time, work on our weaknesses. That could result in eliminating some activities, or adding activities that would give us better positioning in the marketplace. That means we could develop more capabilities in other areas or up our strategic game

 

There is also the need of consistency in our strategy. As we decided to pursue differentiation strategy, all our activities must align on that direction. Some activities don’t need to be differentiation while others are on cost leadership. By not been coherent in our strategic approach that could make us stuck in the middle, and that means no strategy. Also, there is need for effective linkage between the primary and support activities, as well as inter or intra activities. Such linkage leads to cohesion and consistency in strategy. Activities that don’t lead to desired cohesion could be removed, while those that helps us to achieve our goal could be introduced. That is the essence of innovating with the value chain―to create a strategic fit. It’s only when such fit is achieved that we can created a competitive advantage with our differentiation strategy

 

Essentially, the central idea of the analysis of our value chain is to use the insights from the analysis to innovate on our activities in order to create a competitive advantage. The focus is not just to list our activities, but to make strategic decisions based on our performance, as well as the analysis we conducted on competition. Therefore, the analysis is not static by dynamic. As a result, we need to be on continuous look out on the market, and react accordingly. We need to keep a close watch on the competitors, market trends, and technological dynamics of the industry, as well as the economy. Essentially, Okoroh Fast Food need to be on top of its game, by not only focusing on its operations, but more importantly on the external factors that could have impact on the company’s competitiveness  

 

                                        Benefits and Limitations of the Model

Benefits

The advantages of value chain analysis can be seen by breaking product and service activities into smaller pieces in an effort to fully understand the associated costs and areas of differentiation. Using a value chain offers a lot of benefits to your organization, and they include: 

  • It helps you identify key activities within your organization that can help you quickly reduce cost, eliminate waste, optimize effort, and increase profitability. 
  • It helps you reduce the cost of production while simultaneously increasing the value of your product/service.
  • Analyzing the activities within your organization helps to achieve clarity around how your business works which, in turn, helps you make strategic decisions affecting your organization. It also helps you identify elements within the organization that bring greater value to the customers
  • A value chain has the satisfaction of the consumer as its main focus. This helps you create a better experience for your consumers, create a more valuable product, develop loyalty, and ensure repeated purchase of your product/service.
  • A value chain helps you create differentiation from your competition. A well-optimized value chain gives you the edge over your competitors because it helps you create more value than they do.

Limitations

Value chain analysis is no simple feat. The point is that analysis of a firm’s value chain involves integrated thinking, observation, and effective data gathering in order to identify areas where costs can be mitigated or elements of competitive differentiation can be deployed. Specifically, these are the challenges of the model:

  • The value chain model does not put into account the individual needs of organizations or industries. Because of this, identifying tasks, developing plans, and adapting the model to suit your individual needs can be extremely time-consuming. 
  • It is not always easy to find the right information to break your value chain into primary and supporting activities. Also, breaking down your organization’s operations can make you lose sight of your strategic objectives.
  • The value chain model was created before the internet came into being. While it can be adapted to suit digital business, the fit is sometimes not perfect.
  • Conducting analysis of competition depends on the information at your disposal, but most of the information are not at public domain

 

                          Conclusion

Value chain analysis provides a structured approach of assessing where a company true value creation resides. The model is categorized into nine interrelated activities comprising of the primary and the secondary activities. Conducting a value chain analysis helps a company to figure out areas of inefficiency in the business, and therefore implement strategies to optimize value creation and profit maximization. As a framework for analysis of both firm-level and industry-level competitive strengths and weaknesses, the value chain needs to be disaggregated into its strategic components for better understanding of each component’s impact on cost and value. The focal goal of applying the model to conduct operational analysis is to create a competitive advantage. Essentially, competitive advantage can be achieved through cost leadership or differentiation strategies. However, competitive advantage does not emerge by looking at a firm as a whole. It stems from the many discrete activities a firm performs in designing, producing, marketing, delivering, and supporting its product or service. Also, one key component of a fully optimized value chain is innovation. There is need to constantly be searching for innovative ideas that will make the value chain more valuable. Essentially, value chain analysis benefits a company by enabling it to understand how it adds value to its customers. However, there are some limitations of the model, and therefore, combining it with other strategic management tool can help in overcoming the drawbacks

 

 

Omodiaogbe Samuel, MSc. CMC, ChMC, FIMC

Omodiaogbe is a Strategic Management Consultant, and he the Principal Consultant/CEO at Vast Thinking Consults Ltd where he help organizations and business leaders to create superior value. Omodiaogbe holds BSc. and MSc. in Economics. Also, he is a Certified Management Consultant (CMC), a Chartered Management Consultant (ChMC), and a Fellow, Institute of Management Consultants, Nigeria. He is an Instructor on Coursera, where he teaches 25 courses in Strategic Management. Omodiaogbe is one of the world’s leading learners on Coursera and Edx with over 500 Certificates from top-ranked Universities, Business Schools, and Organizations

Contact him:
Email; somodiaogbe@vastthinking.com.ng
Visit: www.vastthinking.com.ng

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