What is the Value Chain Framework?
Economic principles tell us that every transaction occurs at the intersection of two curves - supply and demand. You can try to tailor your customers' demand curves to the optimal level via marketing; however, oftentimes, this can be expensive and difficult to achieve on a large scale.
Sometimes the better answer to increasing your profits isn’t increasing revenue, but actually decreasing costs and improving your supply chain. Poorly designed supply chains can force your customers to go to substitute products and lead to a variety of other issues.
By understanding the value chain framework, you will be able to understand the elements of manufacturing, logistics, and procurement that are crucial to maximizing your firm’s margin. Put simply, your margin is the difference between your firm’s revenues and costs, so the higher the margin, the better.
Michael Porter created the value chain 6 years after he created Porter’s 5 forces, in 1985. The value chain comprises the 5 elements in a supply chain and 4 supporting activities to the production of goods and services (See Figure 1).
There are several supply chain frameworks used in business today, and we believe that the value chain is one of the most effective and elegant articulations of this facet of business. The 5 primary activities of the value chain are inbound logistics, operations, outbound logistics, marketing and sales, and service.
The 4 supporting activities are firm infrastructure, human resource management, technology development, and procurement. It is also important to note that this framework is designed to be more accommodative of different business models, since conventional supply chain frameworks aren’t applicable to service-based businesses. For pure goods manufacturing, the supply chain framework is more valuable, which features 5 elements - raw materials, production, distribution, wholesale, and retail (see Figure 2).
The first primary element in the value chain is inbound logistics, or the receipt of raw materials or inputs of production. You’ve probably thought of inbound logistics mainly as the coordination of inputs, but it is actually deeply integrated with the procurement activities of your firm.
To mitigate disruptions in the inbound logistics phase, your firm should create supply chain contingency plans, which should include secondary and tertiary transportation plans, backup suppliers, and potentially third party logistics providers, who oftentimes have larger and more dynamic logistics networks than your firm’s inhouse logistics.
In addition, having a strong Enterprise Resource Planning (ERP) system can allow your firm to effectively reallocate inventories and manage the size of order to suppliers more easily.
The second primary element in the value chain is operations. Most supply chain frameworks identify this element as production or manufacturing, but the value chain identifies it as operations, since this allows the framework to be applied to service-based business models too.
The operation element is where your firm creates value by either transforming inputs of production into a finished good or delivering a service. As a firm, it is easiest to assess and remedy your bottlenecks during this stage.
Technology development, which is synonymous with research and development in this framework, is deeply intertwined with the operations element. R&D plays a key role in minimizing costs and reducing your production, installation, and service times.
Examples of technology development improving operational efficiency is Toyota’s innovation in car manufacturing. Prior to Toyota’s introduction of just-in-time production, inventory management was a massive complication in auto manufacturing. The Toyota system took advantage of Japan’s deeply integrated supply chains and inspired several other auto manufacturers to do the same.
In addition to technology development, Human Resource Management (HRM) plays a key role in the operations of a company. To implement new efficiencies and scale operations, you must be prepared to bring on and train new staff.
The third primary element in the value chain is outbound logistics. Depending on the structure of the outbound logistics, your margin can either be chipped away by wholesalers and retailers, or the majority can be retained via a direct-to-consumer business model.
Outbound logistics is the gate between production and reaching customers. Disruptions in outbound logistics can be catastrophic for some product groups. Perishables can get ruined and become worthless because of delays in outbound logistics, driving down revenue while also forcing consumers to choose substitute products.
Similarly to inbound logistics, you can introduce a number of tactics and policies to limit vulnerabilities to disruptions. One of these tactics you may want to consider is securing multiple logistics providers and integrating agile logistics processes to accommodate throttles in your production and distribution processes. Once again, integrated ERPs will allow for effective tracking and allocation of inventories and products.
MARKETING AND SALES
The fourth primary element of the value chain is marketing and sales. In contrast to the operations element, where costs are minimized as far as possible, your advertising, marketing, and sales strategies focus on the other side of the profit equation - maximizing revenues.
Advertising is a major activity in this element. Advertising consists of the actual advertisements that your firm is producing and paying for, such as Google or Facebook ads. This can be good for bringing in complete strangers to your lead list, but make sure you are optimizing your ads to avoid wasting any money on impressions that go nowhere.
A good marketing campaign will drive demand and ensure that there are customers for your product or service. Here’s our collection of marketing frameworks that can offer guidance for your marketing campaign, whether you’re just starting or looking to optimize your ROI. Marketing includes everything from how you physically position your product on shelves to passive content marketing (like this blog post!).
Your firm’s sales strategy will depend heavily on what industry you’re operating in. The overall idea of a good sales pitch is to show your prospective clients or customers what value you can offer them, and why they should choose you over the competition.
Finally, the fifth primary element of the value chain is service. If your firm has any warranty policies or ongoing support, servicing will have to be a large consideration for capital allocation. Servicing and warranties must be budgeted for and have proper resource allocations. This ensures that your customers will be kept satisfied with your company, and may end up providing referrals that will grow your revenue.
Fortunately, your firm should be largely in control of its service department, which allows for limited vulnerabilities to disruptions. Large firms, like Apple, have outsourced their trade-in and refurbishing programs to third parties, in order to keep their corporate structures lean.
Procurement refers to the process of purchasing your firm’s inputs that are used along your value chain, and not the inputs themselves. These purchased inputs are needed for daily activities in all parts of the value chain. Procurement is actually needed for all aspects of your firm’s value chain, not just inbound logistics, and can help keep your costs very low if done right. This will involve you finding or setting up deals with suppliers that favor your firm to increase your competitive advantage over the competition.
TECHNOLOGY DEVELOPMENT AND R&D
Your firm likely uses a massive range of technology to assist in areas from email to accounting to virtual meetings. By recognizing how technology and R&D supports your business’ operations, you can ensure that your firm is on the cutting edge, or at least keeping pace with the competition, while minimizing costs to maximize your margins.
HUMAN RESOURCE MANAGEMENT
Human Resource Management (HRM) consists of all activities that deal with your company’s personnel. This includes hiring, firing, payment, training, development, and recruiting. HRM can greatly affect your competitive advantage, so it can be a great investment to find the right people for your business.
Your firm’s infrastructure consists of a number of departments including planning & strategy, finance, accounting, legal, marketing, quality control, and so on. Infrastructure supports the entire value chain rather than the individual activities found within. It is important to ensure that all of your firm’s departments are working towards the same goals to ensure congruence and optimal performance.
Controlling your own supply chain has become common practice for the largest firms in the past few decades. Vertical integration is the process where a firm controls its own supply, distribution, and retail locations. Achieving this can provide your firm with massive leverage and flexibility over the competition, since you are far more agile and are able to manage the intricacies of all aspects of their supply chain.
Once again, a modern example of this is Apple. Apple builds the majority of their own computer components, produces their devices, and sells their devices at an Apple store or online via their website.
Supply chain management is a massive field of study. By understanding the basic structure of a supply chain and its associated value-producing activities, you will be able to identify vulnerabilities in your production and delivery of services.
Although there are several theories that dive into calculations for value chain management, the most valuable element to understand is that each of the activities, supporting or primary, works together to ensure the longevity of your firm.
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