Value chain analysis how-to: Definition, examples, and guide

Value chain analysis (VCA) allows you to increase your company’s profit margin through deep-level understanding of its inner workings.

?At this point in the sales market, there’s no such thing as a truly unique company or product. With hundreds of overlaps in product types, product features, company values, and overall pricing, it’s challenging to stand out from the crowd and even harder to do so without blowing your budget.

Value chain analysis lets you pinpoint the costs and values of every aspect of your business so that you can put your best foot forward and increase your profit margin. When you know exactly where to make cuts or increase investments, you have the power to revitalize your supply and sales chains for maximum benefit.

In this article, we’ll take you through a full explanation of value chain analysis and how it can guide your company toward a more profitable future.

What is value chain analysis?

Value chain analysis (VCA) is a tool used to increase the profit margin for a company by looking for improvements in specific activities along the production and sales lines. Ideally, by discovering opportunities for cost reduction and/or improved customer value, your company can decrease production costs and increase revenue.

Value chain analysis is your path to outperforming the competition and becoming the leading company in your particular field. Just as?sales metrics?and analysis indicate trouble spots in your sales process, value chain analysis indicates the trouble spots in your production process. You can’t fix what you can’t see.

Value chain analysis importance

It’s clear that value chain analysis increases profit margin, but the importance of VCA goes far beyond revenue alone. The VCA process is all about streamlining and alignment. When done right, it not only boosts profits, it also:

• Establishes better vendor management
• Reduces cost and delivery times
• Optimizes inventory
• Improves customer relationships
• Standardizes and optimizes processes
• Helps you gain a competitive edge

While sometimes time-consuming, this?sales analytics?tool is one of the best ways to pinpoint improvement opportunities in your company.

Porter’s VCA

Our current model of the?value chain?comes from Michael Porter’s 1985 book,?Competitive Advantage. Considering how quickly trends move in sales, the fact that we still use this model speaks to how well it works and how much it’s benefitted companies over the years. Porter breaks VCA into five primary activities and four secondary activities that together create value greater than the cost of performing those activities.

That premise makes sense: Profit is created when the overall cost of producing your product is less than the amount you sell that product for. However, it’s common to see companies that don’t track all aspects of product creation and therefore miss opportunities to increase profit margins.

How to do a value chain analysis

There are two primary ways to look at value chain analysis depending on how you’re trying to edge out the competition:

1. Cost advantage analysis:?pulling customers in with low prices
2. Differentiation advantage analysis:?pulling customers in with unique benefits

Let’s take a closer look at both types of analysis.

Cost advantage analysis

Cost advantage is all about lowering. You want to lower both the cost of production and the cost of products. If your company is aiming to do a cost advantage VCA, then you have a product that can be easily mass-produced and holds higher value as a low-cost item rather than a high-quality item.

Great examples of companies that use cost advantage VCA are McDonald’s and Walmart. They use low-cost production to sell massive amounts of products to customers on a daily basis with an emphasis on quantity over quality.

There are five steps to the cost advantage analysis VCA:

1. Identify primary and support activities.?You need to list out all activities used in product creation, especially in supply chain management.
2. Identify the cost of each activity in regards to the overall product cost.?If the overall product cost of a blender is $24, what percentage of that cost comes from each activity? If you discover that one or two activities are accounting for a huge percentage of the cost, scale those down.
3. Identify cost drivers for each activity.?Cost drivers are quantifiable aspects of an activity. For example, the activities of human labor cost drivers include work hours, work speed (KPIs), and wage rate.
4. Identify any links between activities.?Some activities are related and decreased costs in one may lead to increased profit in another.
5. Identify opportunities for reduction.?You can’t cut all production costs, but you can substantially lower them. Look at where your biggest costs are coming from and make adjustments. Some simple tweaks could include decreasing inventory variety, sourcing lower-cost materials, switching vendors, or automating parts of your labor force.

Differentiation advantage analysis

In contrast to cost advantage analysis, differentiation analysis seeks to set a company apart for its product quality and brand value. Sometimes, this process can actually increase production costs, but as long as your overall profit margin increases, that’s fine.

Prominent examples of companies based on differentiation advantage VCA include Apple and Starbucks. Both of these companies sell relatively high-cost, high-quality products with high customization. They win over their customers with branding, features, and other non-financial aspects of their products. For example, you don’t buy a pumpkin spice latte because your wallet says it’s a good idea; you buy it because society now associates it with fun, status, and the essential fall Instagram picture.

There are three steps to differentiation advantage analysis:

1. Identify value-creating activities.?Once you’ve listed all activities, pull the ones that contribute most to customer value. These could include marketing and branding, extra feature production and tech, etc.
2. Look at strategies for improving those activities to increase customer value.?If your product value is coming from brand credibility, look at ways to increase that activity. Perhaps you want to look at social value-based selling and donate part of each purchase to a charity.
3. Identify a sustainable differentiation.?Not all customer-value improvements are sustainable. Look for activity improvements that will keep generating profit over time.

Value chain analysis example

Here is a value chain analysis example for a common supermarket.

Primary activities include:

• Inbound logistics:?very low cost at 2 percent (half of the industry average)
• Operations:?9 a.m. to 9 p.m., seven days a week
• Outbound logistics:?strong presence of distribution centers
• Marketing/sales:?everyday low prices, cash and carry
• Service:?quick responses, no-questions-asked return policy

Secondary activities include:

• Business infrastructure:?400+ truck tractors, 30,000-square-foot stores in small towns
• Human resources management:?top management in-store, employees referred to as associates, incentives, profit sharing, stock options, decentralization
• Technology development:?Uniform Product Code at POS, cross-docking, satellite network
• Procurement:?strong bargaining power with vendors, no one vendor accounts for more than 2.8 percent of total purchases

Based on low costs (inbound logistics and service), long hours (operations), and large amounts of distribution (procurement and outbound logistics), we can look at this example from a cost advantage point of view, meaning we’re looking for an opportunity to lower costs.

Overall, percentages look good for this company:

• None of the supermarket’s vendors account for more than 2.8 percent of purchase (procurement), which means it’s unlikely to switch
• Inbound logistics are extremely low and below half of the industry average
• Maximum work time is used for maximum production and distribution (operations)

So, what could the supermarket do to increase its profit margin?

Let’s take a look at our service primary activity. A universal return is a policy that adds a lot of customer value and brand credibility, but it’s also a policy that costs mass production companies a significant amount of money. Because we’re looking at this company from a cost advantage point of view, it might be worth it for the supermarket to re-examine the return policy.

Supermarkets carry some items which can be reused and some which lose value upon sale (for example, produce). Keeping the refund policy but limiting it to non-perishables cuts back on losses and increases the profit margin while still allowing some refunds (maintaining brand credibility).