Value Chain


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Value Chain

  1. 1. CHAPTER TWO: VALUE CHAIN2.1 HISTORY OF VALUE CHAIN:Supply Chain - For a company, the supply chain is normally a big and wide concept thatdescribes the means by which the company produces products or services to meet its customers’needs.It seems to play a key role in the modern efficient manufacturing concept. In most cases,however, a total or full supply chain concept consists of several networked companies, which allhave the same basic objective: “to fully meet customer requirements”.Value chain - The idea of the value chain is based on the process view of organizations, the ideaof seeing a manufacturing (or service) organization as a system, made up of subsystems eachwith inputs, transformation processes and outputs. Inputs, transformation processes, and outputsinvolve the acquisition and consumption of resources - money, labor, materials, equipment,buildings, land, administration and management. How value chain activities are carried outdetermines costs and affects profits. The value chain is a concept from business management thatwas first described and popularized by Michael Porter. The value chain categorizes the genericvalue-adding activities of an organization.The "primary activities" include: inbound logistics,operations (production), outbound logistics, marketing and sales, and services (maintenance).The "support activities" include: administrative infrastructure management, human resourcemanagement, R&D, and procurement. The costs and value drivers are identified for each valueactivity. The value chain framework quickly made its way to the forefront of managementthought as a powerful analysis tool for strategic planning. Its ultimate goal is to maximize valuecreation while minimizing costs.The concept has been extended beyond individual organizations. It can apply to whole supplychains and distribution networks. The delivery of a mix of products and services to the endcustomer will mobilize different economic factors, each managing its own value chain. Theindustry wide synchronized interactions of those local value chains create an extended valuechain, sometimes global in extent. Porter terms this larger interconnected system of value chainsthe "value system".A value system includes the value chains of a firms supplier (and their suppliers all the wayback), the firm itself, the firm distribution channels, and the firms buyers (and presumablyextended to the buyers of their products, and so on). Capturing the value generated along thechain is the new approach taken by many management strategists. For example, a manufacturermight require its parts suppliers to be located nearby its assembly plant to minimize the cost of 1
  2. 2. transportation. By exploiting the upstream and downstream information flowing along the valuechain, the firms may try to bypass the intermediaries creating new business models, or in otherways create improvements in its value system.2.2 VALUE CHAIN DEFINITIONS: The value chain is a series of activities a product/service must pass through until it serves its final purpose of solving a customer need. In each phase of the value chain the product/service gains some value. If a phase is malfunctioning the chain will break down and the mission of generating value for the customer will not be accomplished. Kotelnikov (2001), A high-level model of how businesses receive raw materials as input, add value to the raw materials through various processes, and sell finished products to customers. John Del Vecchio, a value chain is "a string of companies working together to satisfy market demands." The value chain typically consists of one or a few primary value (product or service) suppliers and many other suppliers that add on to the value that is ultimately presented to the buying public. Interlinked value-adding activities that convert inputs into outputs which, in turn, add to the bottom line and help create competitive advantage. A value chain typically consists of (1) inbound distribution or logistics, (2) manufacturing operations, (3) outbound distribution or logistics, (4) marketing and selling, and (5) after-sales service. These activities are supported by (6) purchasing or procurement, (7) research and development, (8) human resource development, (9) and corporate infrastructure. The value chain is all about how good that product is. What’s its end value? And that means looking at not only the product, but also the value an end user puts on it as well as the cost of disposing the packaging. The goal of a value chain is to deliver maximum value to the end user for the least possible total cost. The successive stages during which value is created when producing, distributing, and servicing a product. Distinct stages in the value chain may include: (1) receiving and distributing raw materials, (2) converting raw materials into a finished product, (3) identifying customers and distributing the product, and (4) providing customer support. Identifying the value chain allows a firm to refine its operations in an effort to improve quality, add efficiencies, and increase profits. 2
  3. 3. 2.3 BENEFITS OF VALUE CHAIN:Creating a ProfitPrimary and secondary activities in a Improvedbusiness relate to production, distribution Logisticsand support. Primary services focus on Enhancedproducing and distributing a product or Return on Customerservice. Secondary activities support Investment Order Managementproduction and distribution. If managerscan successfully manage the connectionsbetween all of these primary and Benefitssecondary activities and keep total costsin the value chain (including production, of Value Increasing Cooperationdelivery and support) below the total acustomer will pay, a value is created for Chain Competetionthe customer and a profit is created for thecompany. Globalization Creating Profit of Supply andCooperation ProductionA company in a value chain such as afood market might work with other producers,processors and retailers to create a betterconnection with customers. Working together, different players in the same market benefit thecustomer and each other. They generate interest in their products and services in the market, andeach player develops a specialty. The relationships with all businesses in the value chain work tomaximize value for customers. These companies also maximize their profits within theirspecialty.Return on InvestmentWhether a business is a producer/supplier, processor, distributor or retailer, it will seek a returnon investment for its participation in a value chain. This investment might seem far off when anorganization first joins a value chain. Remember that the success of the value chain depends onthe ability of its different members to work together toward common goals, such as increasingproduct value for customers. Get a bigger return on investment by improving communicationamong members of the value chain, by getting more players involved and by suggesting newideas that will benefit customers.Increasing Competition and the Primacy of StrategyThe value chain is first and foremost a strategic concept, arising from a strategic theory of firmcompetition. As companies struggle to compete in an environment of globalization and intensecompetition, the focus shifts to alternative means to remain competitive. This creates anincreasing interest in Value Chains as a tool to model the extended enterprise and formulatestrategies for how to remain competitive. 3
  4. 4. Evolving Governance Models for the Extended EnterpriseThe information era spurred on by the recent focus of capital investment on internet technologiesand “dot-com” business models has increased general business and research interest inalternative value chain and business models. This has been promoted in the research literature bythe focus on Core Competencies and the Resource Based View (RBV) of the firm. This growthin modular/virtual collaborative enterprise business models has increased interest in the ValueChain as a primary construction for analysis of new models for business governance.Globalization of Supply and ProductionThe growth in global sourcing and supply has begun a long-term process of leveling the playingfield for adding valueworld wide. This leads to the need to model global value chains as thepredominant mode of business in many industries.Many Benefits Alreadywrung out of Manufacturing and the Supply ChainThe Industrial Engineering and Operations Management disciplines, combined with managementand operations improvement initiatives such as lean manufacturing, TQM, and Six Sigma, havebeen improving the efficiency of manufacturing and supply chain operations for many years.While there is still considerable work to do in the field, academic theoreticians and practitionersat many of the more advanced firms are beginning to turn to a broader view of the enterprise tocontinue making a contribution to improving competitive stance. Improving the operationalcapability of other value added activities in the enterprise, such as product development, requiresshifting perspective from the supply chain to the value chain.Trends in Management DiscourseA final reason for the growing interest in Value Chains may simply be the nature of managementfashion trends in academic and management discourse. A lifecycle process revealing howmanagement knowledge entrepreneurs participate in the creation of trends in discourse wasdescribed in a study of Quality Circles by Abrahamson and Fairchild.Improved Customer ServiceItwas the major benefit those companies (44%) managing from a value chain perspective givesorganization’s a better handle on customer needs at all points the chain. As value chain partnerscollaborate and optimize their processes to better meet customers’ needs customer service shouldimprove.Cost Savings and Accelerated Delivery TimesThe next two most cited benefits form value management reported by companies were costsavings and accelerated delivery times (40%) as inefficiencies and non-value added activities aredozen out of the value chain companies will achieve cost savings in different work activities andareas. 4
  5. 5. 2.4 ADVANTAGES OF VALUE CHAIN:1. A big advantage is that the value chain is a very flexible strategy tool for looking at your business, your competitors and the respective places in the industry’s value system.2. The value chain can be used to diagnose and create competitive advantages on both cost and differentiation.3. It helps in understanding the organization issues involved with the promise of making customer value commitments and promises because it focuses attention on the activities needed to deliver the value proposition.4. Comparing the business model with the competitors using the value chain can give much deeper understanding of strengths and weaknesses to be included in The SWOT analysis.5. It can be adapted for any type of business – manufacturing, retail or service, big or small.6. The value chain has developed into an extra model, the industry value chain or value system which lets you get a better understanding of the much broader competitive arena.2.5 DISADVANTAGES OF VALUE CHAIN:1. It’s very strengths of flexibility mean that it has to be adapted to a particular business situation and that can be a disadvantage since, to get the best from the value chain, it’s not “plug and play”.2. The format of the value chain laid out in Porter’s book Competitive Advantage, is heavily oriented to a manufacturing business and the language can be off-putting for other types of business.3. The scale and scope of a value chain analysis can be intimidating. It can take a lot of work to finish a full value chain analysis for your company and for your main competitors so that you can identify and understand the key differences and strategy drivers.4. Many people are familiar with the value chain but few are experts in its use.5. Michael Porter’s book is excellent but it is a tough read. It’s also dated in its examples which can make some of the ideas more difficult to relate to and understand how things fit together in the Internet age.6. The value chain idea has been adopted by supply chain and operations experts and therefore its strategic impact for understanding, analysing and creating competitive advantage has been reduced.7. Business information systems are often not structured in a way to make it easy to get information for value chain analysis. 5
  6. 6. 2.6 MANAGING THE VALUE CHAIN:How does your organization create value? How do you change business inputs into businessoutputs in such a way that they have a greater value than the original cost of creating thoseoutputs?Manufacturing companies create value by acquiring raw materials and using them to producesomething useful. Retailers bring together a range of products and present them in a way thatsconvenient to customers, sometimes supported by services such as fitting rooms or personalshopper advice. And insurance companies offer policies to customers that are underwritten bylarger re-insurance policies. Here, theyre packaging these larger policies in a customer-friendlyway, and distributing them to a mass audience.The value thats created and captured by a company is the profit margin:Value Created and Captured – Cost of Creating that Value = MarginThe more value an organization creates, the more profitable it is likely to be. And when youprovide more value to your customers, you build competitive advantage.Understanding how yourcompany creates value, and looking for ways to add more value, are critical elements indeveloping a competitive strategy.A value chain is a set of activities that an organization carries out to create value for itscustomers. Porter proposed a general-purpose value chain that companies can use to examine allof their activities, and see how theyre connected. The way in which value chain activities areperformed determines costs and affects profits, so this tool can help you understand the sourcesof value for your organization. 6