Understanding the Value Chain
A business’s value chain describes the activities, resources and business functions involved in the creation and delivery of your company’s offering, usually grouping them into three major categories: People, Assets and Processes.
While a Value Proposition explains the benefits that a particular set of customers receive from a product or service, the Value Chain represents the activities involved in creating that value proposition.
Every business has a value chain, represented by how it takes inputs from external sources (e.g. steel) and converts them into final products (e.g. cars), adding value to them as they move through the process.
These decisions are critical for the creation of a winning strategy, so let’s take a closer look.
Using the value chain strategically
There are multiple ways to make a product and deliver a value proposition, and in deciding how to do it, a company engages in a series of tradeoffs of important strategic implications.
For example, selecting a cutting-edge manufacturing technology may increase efficiency and reduce labor needs, but it could come at a higher cost and bear a higher risk of obsolescence or unused capacity if the product doesn’t sell as expected.
These decisions may compromise your company’s ability to execute its strategy and the flexibility your business will have to change direction in response to changing environments.
Some components of a value chain can support more than one line of products at a time. Amazon’s huge cloud of data servers scattered around the world, for example, support the company’s eCommerce platform and its Amazon Web Services (AWS) divisions at the same time.
Similarly, in a dynamic context, as companies try to build more than one core business, some may find themselves operating two very different, even competing, value chains at once.
Netflix, for example, built its streaming platform while its DVD business was still at its peak. At some point they saw streaming as the future of their business and went ahead and built a powerful streaming value chain ahead of everybody else, developing the capabilities and strengths they needed to thrive in that future environment.
Content streaming has now put the final nail in the coffin of the traditional movie rental business, one that Netflix can now safely leave behind if needed.
A closer look at value chains reveals how the inputs of one are the outputs of another. For example, the steel that’s an input into a car manufacturing operation is the product, or the output, of a steel manufacturing value chain.
Make or buy: Value Chain outsourcing decisions
Taking a broader view, we can see how an entire industry is no more than a huge concatenation of value chains, working as a self-contained network of businesses transacting with each other.
Within this network, incumbents must decide which parts of what they do will be done in-house and which ones will be outsourced to other value chains, and it is from those decisions that an operations strategy is made and a value chain emerges. They are the result of making choices about what the company will and will not do.
These make-or-buy decisions have deep implications for strategy. To start, outsourcing a critical task to an unreliable third party can put your entire operation at risk down the road if, let’s say, a vendor struggles financially or goes out of business.
Apple, for example, decided to negotiate the cobalt, a mineral critical for its batteries, directly with the miners, to ensure that its battery manufacturing partners can get access to the scarce material at competitive prices.
While Apple has deliberately decided to stay out of the battery manufacturing business (a decision about what they will NOT do), it is protecting itself from ending up with vendors that become unreliable for not having the scale to negotiate good deals with the miners, who are also signing juicy deals with the likes of BMW, Volkswagen and Samsung SDI for the construction of electric vehicles.
Second, the way you configure your value chain (i.e. your people, assets and processes) to deliver a particular value proposition determines how easy it will be for other companies to imitate the products and services that your value chain produces.
Put simply, any company trying to copy your products and services would need to replicate your company’s value chain, meaning that the more unique and “aged” your value chain is, the more difficult it would be to copy your products and services.
That’s how a value chain can help avoid competition and keep copycats at bay, and that’s why for a market position to be both profitable and sustainable, it needs to be supported by a distinctive, hence difficult to copy, value chain.
Value Chain versus operational effectiveness
Finally, there’s a clear distinction between a value chain that is distinctive, and one that is efficient, or what Professor Michael Porter describes as Operational Effectiveness.
A distinctive value chain refers to a number of activities and functions that are particularly needed to create a product’s value proposition which work together in a way that is different from what others are doing and difficult to replicate.
Operational effectiveness, on the other hand, refers to best practices that continually improve business processes and reduce costs. The key difference is that unlike a distinctive value chain which is unique to an organization, anyone can reproduce operational improvements and best practices.
Sun Wu’s Strategy for Executives can now be downloaded for free here.
Magretta, Joan. Understanding Michael Porter: The Essential Guide to Competition and Strategy. Harvard Business Review Press. Kindle Edition.
Strategic Positioning, Institute for Strategic Competitiveness. URL: https://www.isc.hbs.edu/strategy/business-strategy/Pages/strategic-positioning.aspx