What’s it: A value chain is the various activities within a business, supporting each other and contributing to creating value for customers. This concept provides a framework for visualizing which areas a company can add value to and how to do so. If successful, it could lead to higher profits. As a result, companies can increase perceived value and reduce costs consumed.
Satisfying customers requires and involves important activities. For example, a company must identify the needs and wants of consumers in the target market. They then develop the appropriate marketing mix.
Next, companies order and purchase inputs from suppliers. They then ship it to the warehouse and process it at the factory. Once done, next, they send it to the customer.
Then, the work does not end there. Companies must also ensure their customers are satisfied and get the benefits they intended when they have given up the money and got the product. So, for example, they provide after-sales service to enable customers to get the benefits they want. Or the company provides a customer complaint channel.
These activities affect customer perceived value, such as quality and delivery time. In addition, they also consume costs.
Thus, companies can focus on value creation efforts in each area by identifying the value chains involved. If successful, they can not only deliver a valuable product or service to their market. But, they can also save costs.
In conclusion, activities in the value chain contribute to adding more value. Companies can maximize profits by creating value in every activity. It allows them to gain a competitive advantage and maintain it over time.
Why is the value chain important?
The value chain gives a framework for developing value creation strategies in the company’s operations. Two reasons why analyzing it is important for companies.
First, companies can focus more on key areas where value creation can be maximized. For example, it may add value to customers, make processes more efficient and effective, and save resource consumption.
Second, the company secures money in the long run. Activities along the value chain contribute to customer satisfaction, whether directly or indirectly. So, by continuously examining value creation along the value chain, they can keep their customers satisfied and loyal. Success in doing so leads to strong and profitable relationships with customers.
Focus on which areas and how the company can create value
Michael Porter proposes a value chain concept to identify areas where a company can create value. According to him, every company synthesizes various interrelated activities, from designing, producing, marketing, delivering to supporting products.
These activities contribute differently to creating value. Some contribute directly to value creation. Meanwhile, others support operations to work efficiently and effectively. And, broadly speaking, they all contribute to customer satisfaction.
Porter then divides these activities into two categories:
- Primary activities
- Support activities
Primary activities include five subcategories. Meanwhile, supporting activities consist of four subcategories.
Each category contributes to creating additional value while also incurring costs. Consequently, companies need to examine them in depth to create economic value in each activity. I mean, they can add value, reduce costs or, ideally, combine the two.
If companies maximize the difference between the added value created and the costs involved, they create high value. Then, because the value is maximized and costs are minimized, they can gain maximum profit and competitive advantage.
Maintaining loyalty by continuously creating superior value.
Creating value basically aims to keep customers loyal. They keep buying and prefer your product. So, by keeping them loyal, money continues to flow into your company.
But, on the other hand, your company also has to compete with other companies to satisfy consumers. So, whether you succeed in making them loyal or not, it doesn’t just depend on your competitive strategy. But, it also depends on the competitor’s competitive strategy.
For this reason, your current success and competitive advantage do not guarantee you will continue to gain it in the future. So, you have to make sure the value you create is superior. And you maintain it over time. It is a prerequisite for the existing competitive advantage to be sustainable.
It requires you to monitor the value you create to stay relevant to your customers’ needs. If you succeed in doing so from time to time, your customers will be loyal to the company. It can result in a strong and profitable relationship in the long term.
How does the value chain work?
Let’s use Porter’s value chain approach. He divided business activities into two categories:
- Primary activities
- Support activities
Primary activities include:
- Inbound logistics bring materials into the business, including warehousing, goods flow, and related information.
- Operations include activities related to processing and converting materials and other inputs into outputs.
- Outbound logistics brings output to distribution channels or delivers it to customers, including handling warehousing, the flow of goods, and related information.
- Marketing and sales create, communicate, and deliver a company’s offering, including handling market research, market targeting, pricing, promotion, and customer relations.
- Service includes all activities to support customers’ satisfaction after buying a product, such as after-sales service, maintenance, repair, and other customer services.
Support activities include:
- Procurement is involved in buying and acquiring goods, services, or work from external sources.
- Infrastructure includes functional activities such as legal, accounting, and general management, which are not involved in directly handling the flow of products within the company.
- Technology is responsible for technology and information flow within the company, such as information systems, production technology, automation, and customer relationship management software.
- Human resource management is involved in planning, recruiting, training, developing, compensating human resources within the company, including being responsible for industrial relations and employee termination.
Creating value in each activity
In each activity in the value chain, the company can focus its value creation efforts. First, it can be by adding value. For example, it contributes to customer satisfaction, making them loyal or willing to pay a high price. Second, companies can also build efficient and effective processes or activities. It saves resources, lowers the costs involved. Both can contribute to creating economic value for the company.
Say your company strives to create customer satisfaction. Many ways do this, for example by:
- Improve product quality.
- Ensure delivery according to schedule and specifications.
- Adopting a customization production system, enabling products according to consumer tastes.
- Provide superior after-sales service.
- Offers additional features.
- Provide friendly and sincere service through superior human resources.
- Improve quality.
- Offer convenience when customers buy.
- Ensure availability when consumers need it.
The alternatives above make consumers happy with the company’s offerings. And, to do so, it requires activities along your company’s value chain to synergize.
Case in point: Walmart’s superior supply chain
Now, take Walmart as an example. The company is the world’s largest-grossing retail giant with revenues of US$559.1 billion in 2020 and has 2.3 million employees.
Walmart can gain a competitive advantage and take a market leadership position in the retail business through an effective and efficient supply chain system. It allows companies to lower their cost structure and offer their customers daily low prices. So how the company does it, let’s focus on its logistics activities.
The first is in procurement activities. Walmart works directly with manufacturers. As a result, it cuts costs by reducing the parties involved.
Just imagine if Walmart bought from a third party like an intermediary – not the original manufacturer. The company may have to buy at a higher price. The intermediary requires money by charging a profit margin (markup). So, by buying directly from the manufacturer, Walmart does not bear the markup.
The second is in logistics activities. Walmart builds a superior logistics network. Enterprise information technology facilitates efficient information between company inventories and suppliers. It allows goods to be available when they are needed by the customer.
Walmart is also streamlining logistics processes through its cross-docking. The company does not involve additional storage to move goods. Instead, the company loads and unloads between trailers by moving from truck trailers to semi-trailer trucks. As a result, it saves costs because the company does not have to bear the storage costs. In addition, goods can be immediately sent to their destination.