Toolkit: Porter’s value chain analysis
January 14, 2009
I discuss Porter’s value chain analysis model.
Toolkit: Porter’s value chain analysis
This post is the third post in a series in which I discuss various frameworks and models that I might be able to use to answer questions on my CGU IST screening exam of Jan 23.
One of the criticisms of Porter’s five forces analysis is that it can tell you about what your problems are (or what your problems would be if you were to enter a new industry), but it doesn’t give you any tools with which to see what needs to change in the firm in order to affect the forces in your favor. Porter proposed his value chain analysis model as an answer to that criticism.
Where the five forces model considers external forces on the firm, value chain analysis looks inside the firm. We consider the firm as a pipeline that converts raw materials into products and services, markets and sells those products and services to customers, and then supplies services to those customers regarding what they’ve bought from us. This pipeline is called the value chain. Each step in the pipeline adds value to the product in the eyes of the customer, and we should end up with our products and services being valued more highly than the sum of the costs of the individual steps in the processing pipeline. The difference between our costs and the value of our product is the margin.
The pipeline has five parts which are traversed in sequence:
- Input logistics: managing raw materials (which might be information) and getting them to the points where we begin transforming them into our products and services.
- Operations: this is where we do something with our inputs in order to get them to the point to where they are ready for delivery to customers
- Output logistics: managing outputs of our operations and delivering them to our customers
- Marketing and sales: convincing people to use our products and services rather than our competitors, and turning them into customers
- Service: after market services; customer support, tech support, warranty repair, value added information, etc.
Additionally, there are four domains which support all five of the pipeline steps:
- Firm infrastructure: this includes existing IT systems, manufacturing systems, etc.
- Human resources: hiring, firing, benefits, learning
- Technology development: this is not just information technology, but also manufacturing technology, delivery, power systems, who knows. Any upcoming technology that can affect us. This is research and development
- Procurement: buying the things we need. Not just raw materials, but all the supporting things that we need also.
The model is usually drawn something like this:
To use this model, we examine the pipeline for a product or service (or a suite of them) within the firm and detail the activities we do to achieve that part of the pipeline. Secondly, we look for linkages between parts of the model. A linkage exists when the cost or quality of one part of the model at least partially determines the cost or quality of another part.
Once we’ve identified our activities, we can examine them in the light of our strategic intent: cost leadership or differentiation. We’ll ignore the “focus” intent because we’re at the level of a particular product or service here.
For cost leadership we’re going to go to our company accountants and have them assign a cost to each activity, and we’re going to look for ways to minimize those costs. Minimizing those costs increases our margin, which gives us the ability to lower prices more than our competitors and still make a profit. We’re going to be looking at these kinds of things: building economies of scale, decreasing or eliminating linkages, geographical factors (be closer to our suppliers or buyers), organizational learning, timing of entry to market, business environment ( regulations, union presence, etc.), vertical integration and how well different business units work together.
For differentiation, we’re going to look at our value chain to see which activities we can leverage or change in order to increase the uniqueness of our product/service relative to our rivals. We’ll be looking at mostly the same kinds of things as for cost leadership: organizational learning, linkages, timing of entry to market, geography, business environment, integration, coordination between business units, policies.
Evaluation for use by CIO
This is an excellent model for the CIO to use in order to better align what the IT organization is doing and providing with the needs of the business. Once the business executives have filled out the model with business activities and how they impact the product pipeline cost, performance and quality wise, the CIO can use that information along with the strategic intent of the firm to look at how the IT organization is supporting and enabling those activities, and how well. By starting with the fully dressed model from the business execs and filling in applications, infrastructure and capabilities the IT org supplies for each part of the model, the CIO can see strengths and weaknesses: where IT support can be improved, where it is sufficient and why, and how to focus research and application of upcoming technologies to better help the firm achieve its strategic intent. Looking at the business options available for promoting our strategic intent in activities in the value chain (listed above) can suggest to the CIO the kinds of projects the IT org should be working on. Are we struggling with inter-business unit cooperation and coordination? Perhaps the IT org should be implementing knowledge management systems, better communication and collaboration systems, and data integration projects.
The value chain analysis model is also effective for identifying IT activities that are ripe for outsourcing. Does it support an activity that is not one of our core competencies (in that it helps us towards our goal of cost leadership or differentiation), and is itself not a core competency? Then it’s a good opportunity for outsourcing.
now completely got it.