What is Value Chain Analysis and How to Use It Properly?

What is value chain analysis and how to use it? This article will show you its background, misconceptions and how to actually implement value chain analysis.

What is the Origin of Value Chain Model?
Value chain is a concept proposed by Michael Porter in his book "Competitive Advantage" in 1985. In this book, Porter explains that "Competitive Advantage" is the ability for a firm to put "generic strategy" into practice, generic strategy includes,

- Cost Leadership: aiming to offer the lowest price to customers.
- Differentiation: selecting the important attributes that buyers want so company can get premium price.
- Focus: doing each strategy according to each market segment.

What is Generic Value Chain?
Value chain is mentioned extensively in the first half of the book and by definition, it's a "strategic framework" about activities that foster generic strategy.

Value Chain Analysis Chart 1

This is classic value chain model. As you can see, it represents various function under "one" company.

What is Value System?
Another related concept is "Value System", it's simply how each value chain (company) is connected with each other.

Value Chain Analysis Chart 2

What is Value Chain Analysis?
"Value chain analysis is a strategic planning tool and it's used to analyze the value chain of the focal company. Value chain is how internal functions create value to customers. Value system is the way each value chain is structured and it spans across multiple companies"

What are NOT Value Chain Analysis?
We know for the fact that many people, ranging from practitioners to academia, don't really understand value chain analysis concept. Then we conduct a quick literature review in this area. Convenient sampling has been carried out to determine the current practice of value chain analysis, 20 scholarly articles available via Google Scholar are examined and the results are as below,

Value Chain Analysis Chart 3

The results are surprisingly shocking! Only 9 of out 20 articles cite Porter as the source of the concept (only 3 of them explain the concept appropriately, the rest of them do value system analysis using unknown methodology). Five articles (mainly from economic perspective) mistakenly use the term to present unrelated concept called "Global Commodity Chain" by  Gereffi, G. and Korzeniewicz, G. (Ed) (1994) Commodity Chains and Global Capitalism.

The surprise doesn't end there, 5 articles present the concept without citing any source, it seems they invent their own methodology and name it "value chain analysis". One paper cites many lean manufacturing articles instead of Porter's so conclusion can be drawn that it's Value Stream Mapping.

How to Use Value Chain Analysis?
According to a literature review, articles related to this concept is extremely unreliable. Then, Original Porter's Competitive Advantage is use as source. Here's how to use value chain analysis:
  1. Defining Value Chain
  2. Capturing Cost Data
  3. Controlling Cost
  4. Cutting Buyer's Cost
  5. Determining Purchasing Criteria
  6. Reconfiguring Value Chain

1. Defining Value Chain : Identify business units/products, determine key functions and include all relevant activities of each function

2. Capturing Cost Data: Estimate costs and assign them to various activities in your value chain. Then, select stronger competitors and determine how they allocate costs to each activity and why.

According to Porter, cost analysis part doesn't need to be very precise, just the estimate is OK. But, a company needs to compare its cost profile against its competitors to reveal the competitor's strategy.

3. Controlling Cost: Find cost drivers and control them such as,

- Scale: expand product lines/facilities
- Linkage: control supplier scheduling, location of warehouse, payment policies
- Timing: Wait until technology is getting less expensive then acquire them
- Investment: focus on technology that cut costs
- Procurement: reduce SKUs, supply base for better volume

4. Cutting Buyer's Cost: Follow these simple guidelines,

- Lower setup cost/time
- Decrease financing cost
- Improve quality/reduce inspection
- Reduce required maintenance
- Speed up processing time
- Reduce required monitoring/control

5. Determining Purchasing Criteria: Try to figure out the key criteria and try to provide favorable delivery timing or improve product features, packaging and appearance or improve after sales/service

6. Reconfiguring Value Chain: Change the way each activity is performed to support strategy