Performing a value chain analysis enables you to break down company logistics, operations and infrastructure to reveal the true value of a product or service. It can also help you uncover a competitive advantage you have over rival businesses.
Gaining a competitive advantage over rival businesses can help you boost company profits and entice new customers. Through value chain analysis, you can evaluate primary and secondary business functions and identify ways to improve efficiency, increase value and stand out from the crowd.
What’s in this piece?
What is value chain analysis?
The term value chain analysis was first coined in 1985 by Michael Porter, a Harvard Business School professor. His book “Competitive Advantage” introduced the basic concept of value chain analysis, outlining how businesses can identify primary and supporting activities and create value for their customers.
Porter’s argument was that if the value a company was offering its customers outweighed the cost of producing it, the result would be a bigger profit.
Value Created - Cost of Creating that Value = Profit Margin
According to Porter, companies can increase their profits by using value chain analysis in two different ways:
- Cost leadership: Cutting production costs and streamlining processes in order to increase profitability
- Competitive differentiation: Increasing perceived value by offering a unique or highly valued service
For example, if your company develops apps, you can gain cost leadership by cutting contracting costs, or gain competitive differentiation by creating more value in your product to demand a higher price tag. Both methods lead to a boost in profit margin.
You can also combine the two methods. For example, if you sell your product or service across many regions, states or countries, your target audience and production costs most likely differ by location.
You may have an opportunity to gain a cost leadership advantage in a region with high production costs by renegotiating contracts. And simultaneously, you may also be able to gain a competitive differentiation in a region where there is an opportunity to boost perceived value.
Regardless of how you choose to use value chain analysis, the logic behind each method remains the same: the more value a company creates, the more profit it can make.
The two levels of value chain analysis
To conduct a value chain analysis, businesses need to split the chain into two levels: primary activities and support activities.
A primary activity is anything that directly impacts the input, output or distribution of products or services. These activities include:
- Inbound/outbound logistics: Receiving, storing and distributing products, goods and services. This activity takes into account practical processes like storage, deliveries, stock and transport needs and costs.
- Operations: Anything that falls under the banner of machinery costs, product assembly and packaging.
- Sales & Marketing: Promoting, advertising, sales and marketing. Any activity that involves boosting awareness of your product or service and building valuable customer relationships to increase trust and close deals.
- Service: From customer support to your finance team, anything that is required to maintain the quality and value of your product during and after a sale.
The second level, support activities, takes into account:
- Research & Development/Technology development: Any budget that’s been allocated to innovative activities such as developing and enhancing new and existing products and services.
- Procurement: Any materials or input that allow a company to undertake its primary activities, such as machinery, consumables and infrastructure.
- Human resource management: All processes and systems relating to managing the people in your organization, such as recruiting, training and retention.
- Infrastructure: Departments like finance, planning, IT and legal.
It’s important to note that a value chain is more than a collection of independent activities. Rather, these activities, both primary and secondary, make up an interlinked system.
Where competitive advantage comes into the picture
Michael Porter: “Competitive advantage cannot be understood 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.”
After conducting a value chain analysis, you’ll be able to identify value gaps in your operations, products and services.
It’s at this stage that you can carve out your competitive advantage and establish measured goals that align with your desired outcome.
This is the strategy you will use to make your product more appealing and boost profit margins. More on exactly how you can accomplish this in step 5: ‘Decide on a competitive advantage’.
How value chain analysis fits into the sales pipeline
Building a relationship and creating trust with a client makes it easier to communicate how your products will solve their problem, in turn helping you close more deals.
You want your prospects and customers to know your product exists and to comprehensively understand the value it brings them. This process plays out in a variety of ways throughout the sales pipeline, starting with prospecting and ending with relationship building and closing.
These activities qualify as a primary activity in the value chain framework and fall under the sales and marketing category.
As your sales pipeline is closely tied to your revenue targets, analyzing it to calculate how many of your leads you need to convert into customers to hit your profit margins is essential. This helps you to build a cost leadership competitive advantage because the less amount of time and money it takes to close deals, the more revenue you can retain. More money to put back into your business means more opportunities to beat the competition.
Moreover, you can analyze how successful your reps are in attracting and qualifying leads and eventually closing deals. You can then note the processes that your most successful reps are using and create guidelines, training sessions and templates to help steer the rest of your team in that direction.
The more effective each rep on your team is, the better your team will perform as a whole. And if your reps become faster and more effective at moving customer’s through the buying journey, you’ll pocket more revenue and benefit from better brand recognition. Boosting your brand’s reputation helps to increase perceived value, giving you an advantage in competitive differentiation.
Evaluating your sales pipeline is one of the most important parts of value chain analysis for a sales team. It can help you streamline your processes, increase market value, pull in more revenue and boost profits.
Five steps to developing a value chain analysis
Step 1: Identify all value chain activities
Identify each activity that plays a part in creating your company’s product. If you don’t, it’s impossible to decode all of the actions involved in the creation, sale and customer after-care.
For example, it’s not enough to write down that you have a product design team. You need to dig deeper and ask:
- How many designers are on that team?
- How much time does each activity on that team require?
- What raw materials are they using?
Once you’ve identified each primary activity in detail, you’ll need to do the same for each support activity.
Pro-tip: This step will take a considerable amount of time and, if possible, shouldn’t be a one-person task. Instead, encourage cross-collaboration internally so each department can outline its logistics, operational costs and services. A task management app like Asana or Trello can keep each activity organized and create a visual chart while you identify each activity in your value chain.
Step 2: Calculate each value chain activity's cost
Next, you need to calculate the exact cost of every activity in your value chain. Remember to calculate contribution costs such as rent, utilities and staff. By having an accurate picture of every single cost, it’s easier to see how much revenue you’re actually generating.
Once each activity has been mapped out, you can delineate which parts of your value chain are costing your business the most money.
According to the Financial Times, a value chain analysis on a £2.50 cup of coffee revealed that only 1p goes to the actual coffee grower. The rest of the £2.49 is made up of additional supplies (i.e. milk, stirrers), transport, rent, staff and taxes:
Using this value chain analysis example, we learn that the most critical component, coffee, is one of the least expensive parts of the cost breakdown. Rent and staff are the most expensive. Knowing this, the company can evaluate and analyze their options.
If they want to reduce rent costs, they can attempt to negotiate their contract. Failing that, they can relocate to a less expensive location. While that may draw less foot traffic, it could potentially boost their profit margin.
If they want to reduce staff costs, they could evaluate how many people are scheduled per shift and perhaps cut staff hours during less busy times.
Alternatively, if they cannot streamline their process or lower costs in any way, they could try to boost their perceived value. They could do this by creating and promoting unique items, or sourcing new ingredients (at a similar cost) that increase sales or engagement.
It’s easy to see why detailed, accurate calculations can make or break the effectiveness of your value chain.
Step 3: Look at what your customers perceive as value
Customers tie value directly to a product’s price tag.
Research shows that although branded and non-branded painkillers have the exact same health outcome, the former is better perceived by consumers. Because customers believe it is more valuable to their health, they’re willing to pay more for the brand name. It’s a classic example of how value perception can impact product margins.
To determine what your customers perceive as valuable, you need to dig into their psychology. Collecting quantitative and qualitative data can help you identify statistical patterns in your customer’s buying behavior.
For example, conducting focus groups, one-to-one interviews or surveys can help uncover what your customers want in a product and how much they’re willing to pay to get it. You can also survey your internal teams, from sales to customer service to account management, to collect data on how customers respond to your products. What are their ongoing pain points? What do they find most useful about the product or service? What specific problems has it solved?
Identifying these qualities will also help your sales reps down the line with prospecting and qualifying ideal customers. Understanding why and how your customers make purchasing decisions boils down to understanding their intent and what they perceive as valuable.
As Rory Sutherland’s TED Talk highlights, the same product can mean very different things to different people. He explains that when it comes to selling a product, there’s no such thing as an objective value. Rather, the value that people place on products comes from factors such as societal influence and group-think.
People often make decisions based on actions that their friends, family and close social groups take. For example, if people in your social circles start to buy noise-canceling headphones to wear at work, you may begin to think of them as valuable. Even if you never considered needing these before, the fact that your friends and family are using them generates interest. This societal influence may prompt you to eventually buy a pair of your own.
Knowing what your customers, and their social circles, desire opens up the opportunity to market your product in a way that motivates them to buy it.
Step 4: Look at your competitors’ value chains
The best way to determine value is through market analysis. Although it’s unlikely you will have access to your competitors’ infrastructure and operational breakdowns, you can use benchmarks as a starting point.
This process is called competitive benchmarking. Depending on the industry and your benchmarking goals, sourcing data about your competitors can be an easy or difficult task.
You can choose to use competitive benchmarking in one of three main ways:
- Process benchmarking: Comparing your process structure and operations against how your competitors carry out tasks
- Strategic benchmarking: Comparing your high-level business strategy to your competitors’ to determine what emulates success
- Performance benchmarking: Comparing outcomes, such as revenue, organic traffic, social media performance, reviews and ratings and so on.
First, you need to determine your competitive benchmarking goals; then, you can conduct research, make a comparison and determine value.
If looking for SEO metrics, for example, you can use an array of online tools to help you collate public information about your competitors’ metrics. If looking for private data, such as cost of goods or profit margins, you’ll need to dig deeper.
This may involve scouring sales reports and press releases for information that the company has made public, or conducting your own research via surveys, phone calls, emails or in-person meetings.
As SmartInsights’ Dave Chaffey explains, you need a baseline to review the marketing effectiveness of competitors. For example, the sales and marketing value chain of online companies can be expansive.
By breaking down the rough costs of your competitor’s online sales and marketing efforts, you can calculate whether your spending is too high. McKinsey recommends using a competitor-insight loop to build insight into your competitors’ strategic planning and decision-making processes:
The key to making this process successful is to tap into the latest data from a competitor’s frontline workforce, such as a blog or shared database, and identify value gaps.
Step 5: Decide on a competitive advantage
At this stage, you will have a clear understanding of your internal costs, what changes you can make and how they stack up to your competitors.
It’s time to pick the competitive advantage of your choice, be it capitalizing on cost advantage or differentiation advantage.
If you choose cost advantage, you need to find a way to optimize and cut the cost of primary and support activities in your value chain. You might choose to outsource talent, replace certain human activities with automation or look for cheaper delivery services. As more and more people start working remotely, you may even get rid of office space.
Any cost cuts you make in the chain can lower the cost of your final product. The more you can push your product prices down, the larger your cost advantage will be compared to competitors.
If you choose competitive differentiation, you must capitalize on increasing the value perception of those products that your customers are most willing to pay for. You can cater to your customers’ most basic desires and needs by recognizing their pain points and repositioning your products as the ultimate solution.
For example, your sales team can highlight your product differentiation during the sales pitch or closing stage in the pipeline by:
- Mentioning the unique benefits your product has that your competitors’ products don’t
- Presenting a case study from a customer that reinforces your position and highlighting relevant data or ROI
- Listing other businesses in the prospect’s industry that have used your product or service and had a positive experience
Apple: a value chain analysis example
When Steve Jobs began building Macs in the 80s in his garage, he wasn't doing it for customers—it was for himself.
"We were the group of people who were going to judge whether it was great or not," he said in an interview years later. "We weren't going to go out and do market research.”
Just over a decade later, Jobs famously quipped: “People don’t know what they want until you show it to them.”
These admissions give us a unique understanding of the mindset behind Apple. While Jobs was insistent on making products that he loved, the company spent massive amounts of money on its internal creative processes—a support activity in their value chain. These investments were made possible because of tight control over the cost of Apple’s primary activities such as operations, logistics and support.
This is what Apple’s value chain analysis tells us about how the company became so successful.
Apple’s Primary Activities
1. Inbound logistics
Apple’s supply chain is enormous.
Its top 200 suppliers provide the company with 98% of procurement expenditures for materials, manufacturing and product assembly. Most of these suppliers are located outside of the United States in Asian countries like China, Japan and Taiwan. The US suppliers the company relies on such as Foxconn and 3M are also responsible for some of its major raw materials.
The suppliers are held to strict quality standards and to streamline this process, the company launched the Apple Procurement Program, which states:
Our business environment is competitive and fast-paced. Our suppliers must understand this dynamic and be agile and flexible in responding to changing business conditions. Above all, Apple values innovation. We appreciate suppliers who truly understand and share in our challenges, and who help us find the best possible solutions.
Every year, the list of suppliers is revisited. Suppliers that meet Apple’s standards and provide a more competitive product are added to the list.
Although Apple sources materials from across the globe, the bulk of its product assembly takes place in Asia.
By taking advantage of lower labor and raw material costs in Japan and China, overall manufacturing costs are also cut. As an example, here is the value chain analysis of the costs required to make the company’s 30GB 5th Generation iPod 2005.
At the time of production, the product retailed for $299. As the table in the article shows, there is a gap of $154.60 between the retail price and the cost of production, which totaled $144.40.
What this step doesn’t calculate, however, is other logistical costs like transportation and distribution.
3. Outbound logistics
Apple products can be purchased online and from the company’s stores.
Because the company has hundreds of retail stores, it can capitalize on keeping any retail margins made through Apple sales. Brand name recognition also means that non-Apple outlets stock the products in large numbers.
A Communications Of The ACM article estimates that Apple gives retailers a 25% wholesale discount. Using this estimate, Apple was left with a gross profit of $80 for the 30GB 5th Gen iPods sold through non-Apple outlets. For any sale made through Apple’s online or customer-facing stores, they also pocketed a $45 retail margin.
4. Marketing and sales
Apple’s marketing and sales efforts are identifiable for its design, quality and innovation.
In 2015, the company boosted its marketing budget to $1.8 Billion, explaining that an “ongoing investment in marketing and advertising is critical to the development and sale of innovative products and technologies”.
Apple’s approach to marketing and sales reflects its chosen competitive advantage: highlighting value. As SeedX Inc Founder Jacqueline Basulto points out, Apple reflects its perceived value not only in the cost of its products but also in its advertising.
“The same applies to their advertising strategy. They want to deliver the best and ads possible or to engage with the most relevant influencers.”
Most products sold by Apple are initially covered by a 1-year warranty and 90 days of support from staff. Customers can book appointments for technical repairs or general product assistance.
They also staff their stores with trained Apple technicians who offer guided, interacted demos to customers. Allowing store visitors to engage with products, in turn, helps encourage them to buy.
Apple’s Support Activities
Research and development:
Apple invests heavily in research and development. In 2019 alone, more than $16 billion was pumped into its R&D program to continue research into products that can maintain Apple’s competitive advantage. The investment pays off: in 2020, the company is releasing seven new or refreshed products onto the market.
Human Resource Management:
Apple was crowned the most admired company for HR in 2019, reflecting its reputation on hiring and paying well. The company is known for recruiting top candidates and even poaching talent from other companies to get the best people working for them.
Conducting a value chain analysis is one of the most powerful processes a business can undertake.
The detail involved in the analysis can uncover where your company spends its money, how well your operations are working and how you can outmaneuver your competitors. In fact, without a detailed value chain analysis, it’s impossible to see where you can lower costs and how to decide what competitive advantage will work best for your product.
At the same time, a value chain analysis is invaluable in identifying wasteful activities in your product production. By sizing up your competitors and tightening up your development process, you can take steps to add value to your product and ultimately—your bottom line.