What is value chain analysis What does the firm gain by successfully using this tool?

What's your business' competitive edge? A value proposition helps businesses identify what sets it apart from competitors. But how can you tell if your business activities are creating the most value for your customers and resulting in a great profit margin? One way to get there is through conducting a value chain analysis.

What is a Value Chain?

A value chain is used to describe all the business activities it takes to create a product from start to finish (e.g., design, production, distribution, and so on). A value chain analysis gives businesses a visual model of these activities, allowing them to determine where they can reduce costs.

With this analysis, you can take steps to create a competitive advantage, improve efficiency, and increase profit margins. Let's take a deeper look into value chain analysis and learn how you can analyze your business activities.

We’ll cover:

• Value Chain Analysis Definition
• Primary and Support Activities
• Value Chain Analysis Steps
• Value Chain Analysis Example
• Value Chain Analysis Templates

What is Value Chain Analysis?

Value chain analysis is a strategic process where a firm evaluates its internal activities to identify how each contributes to the firm's competitive advantage. The ultimate goal of a value chain analysis is to pin down the practices and processes that differentiate a firm from its competitors — for better or worse.

Value chain analysis is a way for businesses to analyze the activities they perform to create a product. Once the activities are analyzed, a business can use the results to evaluate ways to improve its competitive advantage.

While one of the goals of value chain analysis is to improve operational efficiency, its final and most important goal is to establish an advantage over competitors.

As you complete your value chain analysis, you’ll identify the edge you’re trying to gain over the competition. Firms choose between two types of competitive advantage: cost advantage and differentiation advantage. Let’s go over these below.

Competitive Advantage

Competitive advantage is what sets your business apart from competitors. To develop an advantage, you'll need a clear idea of your target market. If you're an entrepreneur who's interested in clearly defining your business' target audience and market, be sure to find the ideal niche market for launching or selling your products.

You’ll also need to know the benefit your product provides to the target market and a solid understanding of your competitors and their offerings. When creating a value chain analysis, a business seeks to gain a competitive advantage in one of two areas.

Cost Advantage

The goal of a cost advantage strategy is to become the lowest-cost provider in your industry or market. Companies who excel with a low-cost strategy have extreme operational efficiency and use low-cost materials and resources to reduce the overall price of their product or service. Examples include McDonald's and Walmart.

Differentiation Advantage

Using a differentiation strategy, you offer a unique or highly specialized product or service to gain a competitive advantage. The business needs to dedicate time and resources to innovation, research, and development. A successful differentiation strategy allows the business to set a premium price for its product or service. Examples include Starbucks and Apple.

It's best to pick a single competitive advantage to focus your efforts on. Depending on which competitive strategy you choose, the goal of your value chain analysis will be to either reduce costs or differentiate to improve margins.

Then you'll have a clear idea of your business' goals and how you plan to provide value. It also narrows the scope of changes that might need to be made to improve efficiency.

But how would you choose which competitive advantage to go for? Using Porter’s value chain model, you can take a look at your business activities, pinpoint a unique value proposition, and decide your best bet for establishing dominance over your competition.

Porter's Value Chain Analysis

Michael Porter, a Harvard Business School professor, introduced a simple value chain model in his book, Competitive Advantage. He developed the steps to perform a value chain analysis and split business activities into two categories: primary and support.

Identifying the primary and support activities is a critical step in creating a value chain analysis. You’ll know where you spend the most resources, where your business may improve, and where your competitors may have an edge over you.

Let’s take a look at these activities below.

Primary and Support Activities

Primary and support activities are the processes and systems a business uses to develop its offering. The five primary activities are inbound logistics, operations, outbound logistics, marketing and sales, and services. Support activities are firm infrastructure, HR management, technology development, and procurement.

Primary Activities

There are five primary activities, and they include all the actions that go into the creation of a business' offering.

• Inbound Logistics: This is how materials and resources are gained from suppliers before the final product or service can be developed. In your analysis, take a look at the locations of your suppliers and shipping costs from their facility to yours.
• Operations: Operations are how the materials and resources are produced, resulting in a final product or service. Here, you may look at the cost of running your warehouse, machinery, and assembly lines.
• Outbound Logistics: Once a product or service is finished, it needs to be distributed. Outbound logistics describes this delivery process. Take into account your shipping costs to consumers, your warehousing fees, your distributor relations (do they charge a fee per sale, for example?), and order processing operations.
• Marketing and Sales: This is how your product or service is presented and sold to your ideal target market. In your analysis, take into account advertising costs, promotional costs, reach, and cost-per-acquisition.
• Services: This is the support a business provides for the customer which can include support and training for the product, warranties, and guarantees. You’ll look at repair costs, product training costs, product adjustment frequency, and more.

Support Activities

Support activities help the primary activities in creating an advantage over competitors. They include:

• Firm Infrastructure: This entails all the management, financial, and legal systems a business has in place to make business decisions and effectively manage resources.
• Human Resource Management: Human resource management encompasses all the processes and systems involved in managing employees and hiring new staff. This is especially important for companies that provide in-person service, and excellent employees can be a competitive advantage.
• Technology Development: Technology development helps a business innovate. And technology can be used in various steps of the value chain to gain an advantage over competitors by increasing efficiency or decreasing production costs.
• Procurement: This is how the resources and materials for a product are sourced and suppliers are found. The goal is to find quality supplies that fit the business' budget.

It’s now time to bring it all together in a unified process. Below, we’ll go over the common value chain analysis steps.

1. Determine the business' primary and support activities.
2. Analyze the value and cost of the activities.
3. Refer to your competitors' value chains.
4. Understand your customer base's perception of value.
5. Identify opportunities to gain a competitive advantage.

Value chain analyses require research and can take time to develop. Below are the general steps it takes to create a value chain analysis.

Step #1: Determine the business' primary and support activities.

Together, the primary and support activities make up the value chain. They include each action required in the development of a product or service, from raw material to final product.

Step #2: Analyze the value and cost of the activities.

The team tasked with creating the value chain analysis should brainstorm ways each activity provides value to customers and the business as a whole. Compare the activity to the competitive advantage you're trying to achieve (cost leadership or differentiation) and see if it supports the goal.

After the value analysis is complete, take a look at the cost of the activities. Is the activity labor intensive? How much does X raw material cost? Asking questions similar to these will help identify which activities are cost-effective and which are not. This is where areas for improvement can be identified.

Step # 3: Refer to your competitors' value chains.

In all likelihood, you're not going to happen upon a nuanced, in-depth picture of your competitors' primary and support activities. A value chain analysis is a means of improving your competitive advantage, so it serves any business that conducts one to keep that kind of information close to the chest.

Still, you can get some concept of your industry peers' value chains through competitive benchmarking — using relevant metrics to compare your company to a competitors'. The practice is multifaceted and is used for three primary functions.

• Strategic benchmarking: comparing business models and strategies
• Process benchmarking: comparing business and operational processes
• Performance benchmarking: comparing business outcomes based on a set of metrics

Once you've identified the category of benchmarking you'd like to pursue, you can pick the competitors you'd like to measure yourself against. Then, you'd choose metrics that you can realistically collect data for and leverage resources that enable the relevant research.

Step #4: Understand your customer base's perception of value.

The customer is always right — meaning however valuable your customers perceive your product or service to be is exactly how valuable it actually is. Customer perception might be the most crucial factor in framing your competitive advantage, so you need to have a pulse on it.

Strides like conducting customer surveys, digging into any qualitative or quantitative data you can piece together, or doing anything else that will cue you into what your target market thinks of you are central to successfully conducting a fully realized value chain analysis.

Step #5: Identify opportunities to gain a competitive advantage.

Once the value chain analysis is complete, the primary stakeholders in the business can see an overview of where the business is excelling and where improvements can be made operationally.

Begin with the improvements that take minor changes and provide high-impact results. After the easy wins are identified and actioned, you and your team can tackle the bigger challenges that might be hindering efficiency.

The value chain analysis gives businesses a clear idea of how to adjust their actions and processes to provide the most value to their target market and increase profit margins for the company.

Still not sure how it all works? Let’s take a close look at an example.

Value Chain Analysis Example

Completing a value chain analysis allows businesses to examine their activities and find competitive opportunities. For example, McDonald's mission is to provide customers with low-priced food items. The analysis helps McDonald's identify areas for improvement and activities that add value to their products and services.

Below is an example of a value chain analysis for McDonald's and its cost leadership strategy.

Click here to enlarge the image.

Primary Activities

• Inbound Logistics: McDonald's has pre-selected, low-cost suppliers for the raw materials for their food and beverage items. It sources suppliers for items like vegetables, meat, and coffee.
• Operations: The business is a franchise and each McDonald's location is owned by a franchisee. There are more than 39,000 McDonald's locations worldwide.
• Outbound Logistics: Instead of formal, sit-down restaurants, McDonald's has restaurants that focus on counter-service, self-service, and drive-through service.
• Marketing and Sales: Its marketing strategies focus on media and print advertising, including social media posts, magazine advertisements, billboards, and more.
• Services: McDonald's strives to achieve high-quality customer service. It provides its thousands of employees with in-depth training and benefits so they can best assist their customers.

Support Activities

• Firm Infrastructure: The McDonald’s corporation has both C-suite executives and Zone Presidents who oversee the firm’s operations in various regions, with a general counsel overseeing legal matters.
• Human Resource Management: It maintains a career page where job seekers can apply to both corporate and restaurant roles. It pays both hourly and salaried rates and promotes its tuition assistance program to attract talent.
• Technology Development: The restaurant has invested in touch kiosks to facilitate ordering and increase operational efficiency.
• Procurement: The firm uses Jaggaer, a digital procurement firm, to establish relationships with key suppliers across various regions of the world.

Value Chain Analysis Templates

Here are a few value chain analysis templates to help you develop your own.

1. HubSpot's Value Chain Analysis Template

Available via Google Sheets and Google Slides, this interactive version of Porter's Value Chain Analysis can be customized to outline your company's value chain. Click here to get your free copy.

2. Porter's Value Chain Analysis Model

This Porter's value chain analysis template provides a general overview of business activities.

3. Template for Cost Profit Margin

If you're analyzing the cost versus expected profit margin from your primary and support activities, this template's for you.

4. Template for Educational Institutions

Rather than analyzing the activities that go into creating a product or service, this model looks at the value chain involved in developing academic research.

5. Template for Products

Use this template to analyze the activities it takes to create a product from raw material to finished product.

6. Template for Financial Acquisitions

Did you recently acquire or merge with another business? If so, use this template to analyze the steps in the transition.

Grow Your Business with Value Chain Analysis

Your value chain analysis will help you identify areas for improvement and the activities that provide the most value to your customers and your business as a whole. Eliminating inefficient business activities speeds up production, improves your competitive advantage, and increases profit margins.

Editor's note: This post was originally published in November 2018 and has been updated for comprehensiveness.

What is the value chain analysis What does the firm gain when it successfully uses this tool?

What is value chain analysis explain?

How does value chain analysis benefit businesses?

What is a goal of analyzing the firm using the value chain?