Value Chain Analysis: Overview, How To Use It (With Examples)

Every business wants to gain a competitive edge. But putting together a highly effective strategy to identify and capitalize on competitive opportunities is easier said than done.

Lowering costs or improving operational efficiency can be difficult if you aren’t clear about how your organization’s activities fit together to create value for your customers. 

Michael Porter's value chain analysis may be your solution. In this article, you’ll get an overview of the most important concepts and the step-by-step process you can use to conduct a value chain analysis.

TL;DR

1. Value chain analysis is a framework that aids strategists in analyzing internal activities that impact business success.
2. It can be used by businesses of all sizes to gain a competitive advantage through differentiation and low-cost strategies.
3. Pros: Value chain analysis shows how the activities in a company’s value chain are linked to each other and influence competitive advantage.
4. Cons: Businesses must have in-depth knowledge about their operations and market to effectively use value chain analysis.

What Is a Value Chain?   

Let’s start with the definition of the value chain. A value chain is a set of activities, processes, and inputs that go into the creation of the final product and deliver value to a  business’ customers. 

All companies have value chains. Here are some examples: 

1. An e-commerce store’s value chain allows a person to visit a website, buy a product, and then have it arrive at their doorstep.
2. A brewing company’s value chain turns hops, water, and barely into a bottled drink that can be sold at bars or stores.
3. A professional services firm’s value chain turns expertise, methods, and experience into specialized tax advisory services for multinational enterprises. 

The output of any value chain is the value or utility it provides consumers. Organizations make their money from the difference between the costs of the value chain and the value they offer (profit margin).

An example of a value chain diagram illustrating the concept. Image source: Harvard Business School

What is value chain analysis? 

A value chain analysis is a strategic framework that helps you analyze nine business activities needed to create a product or service and deliver it to its customers. The goal is to discover gaps and identify opportunities to: 

1. Increase operational efficiency
2. Reduce wasted resources 
3. Increase financial performance and profitability
4. Increase the quality of a product and reduce costs simultaneously
5. Identify a sustainable competitive advantage

A value chain analysis offers a different perspective for businesses engaging in strategic planning to increase their competitive advantage. Rather than focusing on each activity separately, businesses should look at all crucial activities together.

“Management should work to organize the set of activities so they reinforce each other rather than conflict or cancel each other out… This approach forces managers to look beyond the boundaries of their own unit or organizations and see themselves as part of a larger system. Managing interdependencies becomes as important as managing within the organization’s walls.” - Michael E. Porter, Junaid Nabi, and Thomas H. Lee.

What is a competitive advantage? 

According to the value chain framework, companies can increase their competitive advantage by differentiating products or services or lowering costs.

Both of these actions will increase value for consumers and a larger profit margin for the company.  

Cost advantage

A cost advantage strategy aims to increase competitive advantage by lowering the cost of manufacturing a product or offering a service. Businesses should consider this approach if they want to become a cost leader in the market or if there is very little room for product differentiation.

Some examples of companies include Amazon, Walmart, Ford, and Toyota.

Differentiation advantage 

A differentiation strategy aims to increase competitive advantage by increasing the perceived value in the customer’s mind and justifying a product’s price tag. As an example, let's look at Apple. When it comes to iPhone's perceived value, it means the difference between spending a thousand dollars on the iPhone instead of buying a rival's cheaper alternative (but not necessarily lower quality). Diversification is a good strategy for companies who are unable to compete on cost or want to get out of a race to the bottom.

Some additional examples of companies include Starbucks and Coca-Cola.

Primary and Support Activities

Porter’s value chain model divides businesses into nine internal activities under two categories: primary and secondary activities.

Primary activities 

Primary activities directly impact the success of products and services in the market. These activities include inbound logistics, operations, outbound logistics, and marketing and sales.

Inbound Logistics involves receiving, storing, managing, and transporting the materials or components needed for a product or service. For example, a steel manufacturer would need to secure iron ore, coal, silica, and other source materials needed to produce final products in their factories. 

Here are some examples of activities:

1. Receiving materials
2. Designating storage space
3. Ensuring proper storage
4. Managing inventory

Operations refer to business processes that turn source materials into finished products. This includes designing and manufacturing products or services. For example, a vehicle manufacturer’s operations could include raw material quality checks, assembly processes, and quality assurance during and after the production process.

Outbound Logistics involves storing, transporting, and distributing finished products to consumers on time and in line with market demand. For example, a semiconductor company based in China or Taiwan must get products to various companies worldwide to make money. This whole process might include activities such as:

1. Packaging
2. Logistical planning
3. Sorting
4. Storage
5. Distribution

Marketing and Sales are activities related to promoting, advertising, and pricing products and services. For example, a professional services firm must get its offer in front of the right audience that needs its services and will pay for them.

Example activities:

1. Market research
2. Digital marketing
3. PR activities
4. Selecting advertising channels
5. Advertising campaigns

After-Sales Services are activities that ensure a positive customer experience after a sale has happened. For example, an appliance maker or car manufacturer must offer after-sale support and services to ensure their customers are happy. 

Example activities:

1. Customer service
2. Warranties
3. Account management
4. Repairs
5. Returns and replacements
6. Client success

Support activities

Support activities indirectly impact the value chain of products and services for businesses. 

Procurement activities deal with the sourcing, selecting, and purchasing of raw materials, equipment, and components for a business.

Infrastructure relates to managerial, financial, and legal systems that help an organization make decisions, operate, and manage resources.

Human Resource Management deals with an organization's people and includes recruitment, training, compensation, and employee management.

Technological Development relates to innovation research, development, and implementation at various value chain stages to improve efficiencies and products.

How to Perform a Value Chain Analysis in 6 steps

Your business should perform a value chain analysis on a regular basis. In an ever-changing market, it's crucial to keep an eye on how you stack up against your competitors. Follow these steps to assess your value and refine your operations.

1. Identify primary and support activities 

The first step is to determine what is the perceived value of your product or services, and identify the activities in the process chain that create the most customer value. Break down all business activities of the organization into either primary or support activities. Each activity should also be broken down into its basic elements. 

This involves a correct identification of direct activities (activities that generate value on their own), indirect activities (activities that support direct activities), and quality assurance (activities that ensure direct and indirect activities meet the requirements). 

For example, if you’re analyzing your inbound logistics activities, you’ll need to look at receiving, storage, warehousing, inventory management, etc. 

💡Tip: This step requires adequate knowledge of the company’s operations. Organize a brainstorming session and bring in various stakeholders from your organization. You’ll get access to different perspectives and insights that you might not be able to discover on your own.

2. Evaluate the cost of each activity

If you want to compete based on cost, you need to focus on the cost of each activity. Go through the business’s primary and support activities and answer these two questions:

1. What does the activity cost the company?
2. How much does it contribute to overall product cost?

Let’s say that you are a manufacturer of wooden chairs. The overall product cost of a chair is $85. In the next steps, you should identify each activity and percentage that contribute to the overall cost. 

Is there an activity that accounts for a large percentage of the cost? If so, you should look at opportunities to reduce the costs of that specific activity first. 

If your goal is to create a cost advantage, then you also need to understand the cost drivers. Michael Porter identified 10 cost drivers:

• Economies of scale
• Learning
• Capacity utilization
• Linkages among activities
• Interrelationships among business units
• Degree of vertical integration
• Timing of market entry
• A policy of cost or differentiation
• Geographic location
• Institutional factors

Porter's 10 cost drivers are factors that can affect an activity's cost. By controlling these cost drivers, an organization can improve efficiency, create value, and differentiate itself from the competition.

3. Identify which activities create value for your customers

If you want to create an action plan based on differentiation, you should focus on a value chain analysis with a slightly different approach. When it comes to value, you should look at it from your customer's perspective. 

Think along the lines of:

• Product features
• Quality
• Marketing & Branding
• Product design
• Services around your product that contribute to positive customer experience
• Customization
• Complementary products

There are many ways to differentiate a product, including improving its quality, offering faster delivery, or adding more features. Additionally, it can mean updating your packaging, changing how items are sold, and trying out new marketing strategies.

Does most of your product or service value come out of customer support or brand identity? If so, you might want to consider investing more resources and budget into those activities.

4. Analyze the relationship between different activities

Look at the links between each activity in the business value chain. A change in one activity might affect another's profitability. 

For example:

1. Procuring higher-grade materials may lead to better product quality and fewer product returns. 
2. Outsourcing specific tasks like accounting and customer service may allow you to reallocate internal resources elsewhere.
3. Renting out warehouse space during quieter periods could help reduce your inbound and outbound logistics costs.

5. Identify your best opportunities for competitive advantage

If you chose a differentiation approach, ask yourself which parts of your value chain offer the best opportunity to achieve differentiation. The analysis may suggest that you need greater or more expensive resources to increase product value, create loyalty, or differentiate yourself from your competitors. Investments in additional resources must be justified by the value created. 

If your main goal is to create value through cost-cutting, take a look at each piece of your value chain through the lens of reducing expenses. Which steps could be more efficient? Some of the resulting opportunities may be as simple as negotiating with suppliers on raw material costs. Or identifying activities that are better served by outsourcing. In some cases, you can design a product, but outsource the manufacturing or building of the product.

Get as clear as possible about what strategy you intend to pursue and how. Identify who will have to execute chosen initiatives and where will these actions have the most impact on value. This is essential for the next step.

6. Execute your strategy

The Value Chain is a worthless exercise if it is not followed by an action plan and execution. After completing your value chain analysis, select a few quick wins and put them into motion right away. Don’t fall into a cycle of planning and revising. Start executing as soon as you have an idea of which strategy you want to pursue. 

However, you need to have in place a strong management structure that will help you monitor progress, hold teams accountable, and empower leaders to lead the change. 

As an example, Cascade helps you build your action plan and assign an owner to each initiative and objective. This will give you a high-level overview of the performance of your teams and identify any setbacks before they become a serious problem. This is important if your value chain strategy includes changes across multiple areas at the same time. You’ll be able to keep your cross-functional teams aligned and accountable for progress. 

A strategy execution platform like Cascade can streamline the process of communicating your action plans, measuring, and executing strategic initiatives.

Value Chain Analysis Example: Ikea

IKEA is one of the largest furniture manufacturers and retailers in the world. Here’s how a value chain analysis would look for this global brand.

Primary activities 

Inbound Logistics 

• IKEA inbound logistics is a major source of value creation for the business. They have 1220 suppliers worldwide. The company has strategically placed distribution centers worldwide and trading offices near suppliers to minimize transportation costs. 
• A trading service office located near a supplier location allows the company to monitor production, negotiate prices, and check the quality of raw materials and products they purchase.
• With IKEA's flat pack-assembly principle, packaging costs are reduced and inbound logistics are simplified.

Operations 

• The company operates a franchise business with over 458 locations worldwide. This helped them to expand internationally faster and at lower costs. They selectively outsource manufacturing and sell unassembled items to reduce unnecessary overheads.
• IKEA has 40 furniture production units, most located in Europe, and two factories that produce furniture components (screws, plugs, etc.). With a large number of manufacturing units located in Eastern Europe and China, the company saves a significant amount of money on human resources.

Outbound Logistics 

• IKEA minimized its expenses by creating its own distribution system and distribution centers. Customers are responsible for costs associated with the transportation of goods purchased from IKEA stores. 

Marketing and Sales

• The company markets the IKEA brand through media advertising, promotions, product placements, social media, and digital marketing. In order to cut marketing costs, one of their strategies was to cancel physical catalogs. 

After-Sales Services

• IKEA’s after-sale services include a 365-day exchange/return policy, measuring, assembly, and installation assistance. They also offer assistance with sourcing spare parts and operate furniture removal and recycling services. However, they are not famous for superb customer service which might be a result of their cost-cutting initiatives.

Support activities 

Firm Infrastructure

• Corporate management is centralized in the Inter IKEA Group, which oversees the strategic direction of the business. They also have an operations management team to manage supply chains, while franchisees manage individual stores.

Human Resource Management 

• IKEA leaves in-store hiring and HR management to franchisees. However, they offer employees skills development, training resources, and general well-being support.

Technological Development 

• IKEA utilizes integrated cloud computing, improving inventory management and data storage to enhance various aspects of their value chain.

Procurement

• The company buys a combination of raw materials and finished products in volume to reduce purchase prices on key category choices and only utilizes large suppliers capable of delivering their required quantities.

📚Recommended reading: Strategy study: How IKEA became a household name 

Benefits of Value Chain Analysis 

The main benefits of value chain analysis are: 

• It helps you to identify value gaps and carve out your competitive advantage so you can formulate your differentiation strategy 
• Gives a clear understanding of the interconnectedness of business activities and how they influence business success.
• Can help maintain alignment when planning and executing cost advantage and product differentiation strategies.
• Allows leaders to systematically examine business units for strengths and weaknesses that can be addressed.

Cons of Value Chain Analysis 

The main cons of value chain analysis are: 

• The goal of value chain analysis is to break things down. Finer details are important, but if you rely on them too heavily, you may lose sight of the big picture.
• It can be difficult to apply value-chain analysis to complex business structures.
• Getting accurate, up-to-date data and metrics to perform a value chain analysis can take time and effort.

Value Chain Analysis + Strategy Execution = 🚀 

Value chain analysis helps businesses understand their operations better and identify sustainable competitive advantage. However, the key is to turn insights into action or you won't see any results.

How to do it? Using a centralized platform to manage your strategic initiatives in one place. This will help you keep your teams aligned and quickly adapt when disruptions occur. 

Thousands of teams around the world rely on Cascade's strategy execution platform to see faster results from their strategies. 

Curious to see it in action? Take it for a spin for free or book a call with a Cascade expert.