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.
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.
The term value chain analysis was coined in 1985 by Michael Porter, a Harvard Business School professor. His book “Competitive Advantage” introduced the basic concept, 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.
To conduct a value chain analysis, businesses need to split the chain into two levels:
A primary activity is anything that directly impacts the input, output or distribution of products or services. These activities include:
The second level, supporting activities, takes into account:
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.
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.
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.”
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’ below.
Building a relationship and creating trust with a client makes it easier to communicate how your products will solve their problem, which means more deals closed for your company
You want your prospects and customers to know your product exists and to 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.
Identify each activity that plays a part in creating your company’s product.
For example, it’s not enough to write down that you have a product design team. You need to dig deeper and ask:
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.
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 like:
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. Having this information, the company can choose their next steps wisely.
It’s easy to see why detailed, accurate calculations can make or break the effectiveness of your value chain.
Know that customers tie value directly to a product’s price tag, in other words, perception greatly impacts product margins.
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.
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.
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 didn't want to buy them before.
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.
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.
You can choose to use competitive benchmarking in one of three main ways:
First, you need to determine your competitive benchmarking goals; then, you can conduct research, make a comparison and determine value.
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.
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.
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:
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 a very successful brand. 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 supply chain is enormous.
Its top 200 suppliers provide the company with 98% of procurement expenditures for materials, manufacturing and product assembly.
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 to ensure optimization of their value chain.
Apple takes advantage of lower labor and raw material costs in Japan and China, overall manufacturing costs are also cut.
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.
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 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.
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.
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