Value Chain Analysis: An Approach to Rein in Costs

In competition economic environments, firms are scrambling to pinpoint areas that can be improved, consolidated or revamped. The free market is now more unforgiving than ever before with firms taking unprecedented risks to take lead in the markets they operate in. Against this backdrop, businesses have resorted to value creation and cost competitiveness to stay relevant and competitive. Hence, it makes much sense to shed light into a critical component of business analysis- value chain analysis.

Value chain analysis is the process of breaking down the entire business process and identifying those activities of the process which creates value. The areas are clustered into two primary groups. The idea here is to identify the areas so as to manage value creation and control costs more effectively. Value can be created by almost any business but the challenge is to make it continuous, differentiated,relevant and sustainable. The value chain analysis also offers a firm a closer look at its internal machine and offers an avenue towards a holistic internal analysis.

Another aim of the value chain analysis is to consolidate your cost advantage. Cost like value is king in the world of business. Lets see how a firm focusing on cost competitiveness carries out the value chain analysis

1. The first step entails clustering activities in two groups- primary and support activites. Primary activities will contain the following sets of activities- inbound logistics, operations, outbound logistics, marketing&sales and services. Support activities include firm infrastructure, HR management, technology development and procurement.

Inbound logistics include the processing of raw materials, how firms transport them from markets to its production systems. Operations refer to the activities that process the raw materials into final products. Activities include machining, packaging, assembling etc. Outbound activities refer to activities that take the products to the market such as warehousing, order fulfillment, transportation, quality testing and distribution. As for marketing& sales, these represent efforts that take place over multifarious mediums to log revenues. Services refer to dealer support and after sales services.

Firm infrastructure refers to firm’s assets both tangible and intangible. HR managements refers to the tasks of hiring, training, processing, processing, promotion of employees along with maintaining a sustainable culture. The wage and benefits issue also comes into play. Technology  development refers to the immersion of IT in business processes and procurement refers to the purchase of input.

2. The second step would be to allocate total costs to each activity. This would require you to gauge the importance of react activity. Normally ,the higher the cost, the higher the importance. The idea here is to scan the entire cost structure of the firm and assign a particular level of importance to each activity in the cost structure.
3. The third step entails find the cost drivers. This means looking for significant variables that is likely to affect the total cost of an activity. For instance, in marketing&sales activity, ATL advertising costs are likely to be the most significant. In this way, by keeping tabs on the significant cost drivers, the firm can devise ways to be more cost efficient.
4. The next step is to find a relationship between or among levels. The idea here is to find out whether there is any knockdown impact if the costs of one activity are curtailed. It is very likely that by making operations lean and more efficient, the firm will be able to control outbound logistics cost as well. On the other side of the fence, reducing costs may lead to costs rising in other activities as well .For instance, if the firm wants to buy in bulk to reduce purchasing costs, the costs of warehousing is likely to increase as well. So, by mapping out relationships the firm will be in a better position to rein in costs.
5. Assign value targets to cost drivers- After the significant cost drivers and their relationships with other costs have been identified, it is important to assign best practices to those drivers. This will provide the firm with a focus and dictate the efficient usage of resources.
6. The final process is to evaluate whether best practices are followed accordingly. Random checks must be made in this regard.