Feature | Reviewing the Value Chain

Reviewing the Value Chain During an Economic Recession

In his 1985 book ‘Competitive Ad- Most of the terms used for the primary been in producing something that can
vantage’, Michael Porter introduced activities are self-explanatory, except be sold at a price exceeding the cost
a generic value chain model that was that they are probably easier to under- of the activities in the value chain. It
built from a sequence of activities stand in the context of a physical prod- is in these activities that a firm has an
found to be common in a wide range uct. Inbound logistics, for example, opportunity to create greater value for
of organisations. Much of the literature would include receiving goods from the customer. A competitive advan-
describing this model uses manufac- tage may be achieved by reconfiguring
suppliers together with quality inspec-
turing as the business model but it is the value chain so as to provide either
tions. Operations would involve trans-
equally applicable to the provision of a cost advantage or better differen-
forming goods received into some kind
services, which is a more prevalent
of product available for sale. The ac- tiation. How is this different to simple
model in the Armenian business envi-
tivities here could range from simple cost-cutting? Well, we can say that it
ronment.
things such as placing the items on is focussed more on obtaining a com-
When entities start to feel the impact petitive advantage rather than on basic
display to assembling components into
of a recession their first reaction tends survival. You could also say that cost-
finished products. Outbound logistics
to be one that involves cutting costs.
is concerned with how the goods are cutting is reactive (a knee-jerk reac-
Figure 1 The value chain transferred to the customer. Market- tion) whereas value chain analysis is a
proactive way of coping with the prob-
Firm Infrastructure lems of a recession; we are trying to
HR Management find ways of doing things better so as
to provide more value to the customer.
Technology Development
By undertaking a value chain analysis
Procurement
the firm will be able to identify where
Inbound it can obtain a competitive advantage.
Outbound Services
and Sales But first we need to refer to another
of Michael Porter’s models, known as
Porter’s generic competitive strategies
(1980). According to that model there
are only three internally consistent and
successful strategies for outperforming
But simply cutting costs with only a ing and sales is self-explanatory and others, namely:
passing thought as to its effect on the
the Services activity relates mainly to
value chain can be dangerous and any •• Cost leadership
after-sales service. Although this ex-
cost advantage in the short-term might
planation is in the context of a physical •• Differentiation
be offset by lost business in the long-
term. In some cases it might be better product, the principles are much the •• Focus
to ride out the storm until value starts same for service products. It is usually
Cost leadership means being able to
coming back into the market. At the much easier to identify where value is
produce something at a cost which is
very least cost reduction needs to be added in the primary chain than in the
focussed on activities that are not add- lower than that of the firm’s competi-
support activities. The value added by
ing value to the product, but deciding tors. It defends the company against
support activities is not always readily
which activities do not add value is no all competitive forces. Differentiation
apparent and an analysis here tends
easy task. is to worry less about costs but to of-
to focus on what would happen to the
To understand Porter’s value chain we fer something that competitors are not
business if some of these activities
need a diagram of the model. It is usu- offering, whereas the focus strategy is
were curtailed.
ally presented as shown in Figure 1. built around serving a specific (niche)
The five primary value chain activities The head of the arrow is meant to il- market extremely well. Within the fo-
are shown at the bottom of the dia- lustrate the firm’s margin (profit) and cus strategy, cost leadership and dif-
gram and the four support activities are this will depend on how effectively the ferentiation are options. In terms of the
placed above the primary activities. primary and support activities have value chain model we should concen-
92
93
 Feature | Reviewing the Value Chain

trate (we hesitate to say focus) on cost is categorised as either high or low and A differentiation advantage can be ob-
leadership and differentiation. this produces a typical diagram with tained either by changing individual
four-quadrants as in Figure 2. Busi- value chain activities to increase their
Cost leadership
ness analysis models always appear uniqueness or by reconfiguring the
(cost advantage)
to be over simplistic when you first try value chain (often at the operations
By better understanding costs in the to apply them but it is the process of stage) in some way. If we take, for ex-
value chain it should be possible to trying to apply them that their benefits ample, a training company we would
see where a cost advantage can be are found. For example, a travel agen- probably find that the ‘operations’ and
obtained, either by reducing the cost cy found that its customer relationship ‘outbound logistics’ activities in the val-
of an individual value chain activity management (CRM) was highly disor- ue chain are nothing more than agree-
or by reconfiguring the value chain in ganised with several members of staff ing a contract with a trainer, arranging
some way. The basic idea is to elimi- creating their own individual database a venue, producing training materials
nate costs that are not adding value to of customer information. CRM is of and delivering the course. Not much
the firm’s products. This does not have high strategic importance to a travel here to create uniqueness it might
to entail dismissal of staff; it might be agency, although the process of creat- seem, unless the trainer was some
possible to reconfigure the activities ing and maintaining the information is internationally recognised guru that
through a re-training programme. Such relatively straightforward. It clearly falls everyone wanted to hear. And where
an exercise will involve defining the into the bottom right quadrant in Har- would one put this activity in Harmon’s
value chain and then assigning costs mon’s matrix and by becoming aware matrix? Probably in the top right box
to each activity. It is unlikely that the of this the company was able to estab- because even though the process
accounting records will reveal these lish a centralised automated system itself is not very complex it is of high
costs directly and even where they do using proprietary software. It was by strategic importance and it is difficult to
it will still be necessary to consider fac- examining the cost drivers in different imagine how much of it could be au-
tors that are driving the costs. For ex- value chain activities that the company tomated.
ample, the cost driver of an accounts has been able to secure a competitive
But if we look more closely at the op-
department (which is part of the firm’s advantage.
erations of this company we might find
infrastructure) is not simply the number
Differentiation in the value something that can be made unique.
of the accounting staff; that particular chain For example, you might find that some
cost will also be influenced by ‘institu-
Differentiation is based on uniqueness. of the training material is reference
tional factors’ such as compliance with
accounting and tax legislation. In fact,
Porter identified 10 cost drivers related
to value chain activities and they in-
clude various things such as stage in
the learning curve, capacity usage,
and the degree of vertical integration.
Figure 2 Harmon`s process strategy mix
It is by controlling the cost drivers better Strategic importance
Low High
than competitors that a cost advantage
can be obtained. If we return to the ex- High value processes that
Not part of company’s core
ample of the accounts department we create
competencies. to
High advantage. Requires careful
will probably find that a lot of the work automate but could be
process improvement
here is repetitive and routine. If this is outsourced. Examples:
focussing on people and their
so it might be possible to reduce costs and
skills
Process
either by automation or by outsourc-
complexity
ing. In making decisions of this nature
it is useful to refer to a model in Paul Simple but important. Can be
Automate with -the-shelf
Harmon’s book ‘Business Process automate d to improve
Low sytems or outsource.
efficiency. Example:
Change’. As with many models in busi- Example: payroll Customer relationship
ness analysis it has two vectors; in this manage ment (CRM)
case they are ‘Strategic importance’
and ‘Process complexity’. Each vector
94
Feature | Reviewing the Value Chain

Figure 3 the value system

... Suppliers The Buyers

material that the participants will need benefit from any economies of scale or relationships when the economic cli-
to review later. This does not have to technical advances in the industry into mate is more favourable.
be produced in paper form; it could be which it has diversified. For example,
The cost of a value chain
placed on a website to which partici- a book publisher would probably find
analysis
pants have access by means of unique it more efficient to outsource the print-
password. In fact, by simply looking at ing of books to a specialist printing At a time of recession it might seem
this idea it is possible that other ini- company where the machinery can be contradictory to suggest that a firm
tiatives might come to mind such as worked to full capacity by printing for should undertake an analysis of its val-
setting up a web-based discussion fo- many other firms. A firm of accountants ue chain; how will it find the money to
rum available to participants. By using might find it more efficient to outsource pay for such an exercise? This ques-
technology in this way the company is its training requirements to a training tion assumes that it will be necessary
obtaining both a cost advantage (sav- company where it can take advantage to engage external consultants to do
ing in paper) and a differentiated prod- of the quality control and technical up- the work but this does not have to be
uct by reconfiguring its value chain date procedures in which the training the case. Many of the large organisa-
activities. firm specialises. tions that stand to benefit from a value
chain analysis are likely to have an ex-
The value chain system Many large and powerful companies
pert already in their employ. We are re-
A firm’s own value chain is part of a try to exercise less formal power over
ferring here to members of ACCA, or at
much larger value chain system in- suppliers by using their bargaining
least a student member of ACCA who
volving suppliers, distribution channels power to achieve more favourable pur-
has studied and passed an examina-
and customers. Porter refers to this as chase prices. Whether or not the firm
tion known as P3 Business Analysis.
the value system and the basic idea supplying the product can defend itself
against this kind of bargaining power All too often we notice that our modern
can be illustrated as in Figure 3
might depend on its ability to con- finance professionals in Armenia are
When discussing this system some not being used to obtain the best value
trol costs within its own value chain.
jargon is used, based on the flow of a from their services. There is a mind-set
A more subtle advantage is gained
river. For example, if you look at sup- that believes a qualified accountant is
by fostering good relationships (both
pliers from the firm’s perspective you someone who will look after the money
upstream and downstream) that can
are looking upstream; if you look at and make sure that the firm complies
promote innovation and create knowl-
distribution and customers from the with accounting and tax law. Admit-
edge. During times of a recession it
firm’s perspective you are looking tedly the compliance function might be
might be tempting to think of one’s own
downstream. one of the chief accountant’s respon-
survival by ignoring the plight of oth-
If the firm wanted to have absolute ers in the value system but we need to sibilities but a lot of the work that it
control over the whole value system keep in mind that a recession does not entails can be automated, outsourced,
it would clearly need to have a high last forever and there will be a time in or done by an accounting technician.A
degree of vertical integration both up- the future where the firms need each modern finance professional is trained
stream and downstream (by owning other again; all links in the chain are in business strategy; these are skills
the entities in the value system). But in dependent on each other. Our suppli- that are vital to a firm’s success. By
many cases this might not be efficient. ers and customers are stakeholders reconfiguring roles in the accounts de-
There several reasons for this, such as in our own business and by working partment it should be possible to use
digressing from the firm’s core com- together in difficult times it will be pos- these skills in a way that adds value
petences and sometimes by failing to sible to reap the benefits of those good to the firm.
95