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Essay Importance Value Chain Analysis

Value Chain Analysis

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Value Chain Analysis"Accounting for Strategic Management Porter identified the 'value chain' as a means of analysing an organisation's strategically relevant activities in order to understand the behaviour of costs. Competitive advantage comes from carrying out those activities in a more cost-effective way than ones competitors.This essay describes the activities which are referred to as the value chain and discuss how cost analysis of the value chain can be achieved in order to facilitate cost-effectiveness.M. Porter (in Competitive advantage, 1985) breaks the value chain (VC) model into two distinctive types these being primary and support activities. (Bowman C., 1990, p63) The model suggests, that no matter how many operational units that are involved in the process of generating customer value; these primary activities can be conceptualised into five generic stages. The five primary stages are inbound logistics, operations, outbound logistics, marketing and sales, and service. These primary stages are supported by the firms infrastructure, human resource management, technology development, and purchasing and procurement. The stages within the VC should not be seen in isolation but looked at in a wider context and include the interactions between stages not just within the processes. The relationship between sales, operations and procurement for instance can determine how much stock is to be carried and therefore reflected in cost of inventory held.When analysing the VC of a given company/organisation the management accountant (MA) should firstly identify the activities of the firm to establish the framework of the chain.•   o ". . . Porter suggests the detailed assignment of operating costs and assets to each value activity" (Grant R.M., 1995,p193) A company producing computers and a firm of accountants for instance would display very different components within the chain due to the differentiating activities (see below); this framework will allow us to establish the relevant importance of each unit of activity in regards to costs. As you can see the relevance of operations within the manufacturing company is higher than that of operations within accountancy. With over 60% of its costs being allocated to operations, it would seem that the manufacturing company should concentrate on this area to maximise savings, as this is the main cost driver. The accountancy firm however as two main cost drivers these being operations at 26% and marketing at 21% , suggesting almost equal saving potentials can will be offered. As MA’s we need to identify the cost drivers, in a similar manner as ABC costing.

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these being costs of, capital equipment, volumes of production, down time due to changes in production, wage rates, and rates of rejection due to quality defects. Porters identifies 10 ‘cost drivers’ the most quantifiable of these being economies and diseconomies of scale, learning or experience effects, and capacity utilisation. Where the traditional costing approach focuses on the operations within manufacturing VC cost analysis concentrates on customers value perception. When considering the VC one must not totally rely on producer costs but must also consider the consumer costs involved; this is the further processing of goods or services as required by the customer. The cost of a car or van for example does not only include the purchase price but such factors as devaluation and service costs. Cost objectives in the traditional model being products, functions, and expense heads whereas the VC concentrates on value creating activities and product attributes. The organisational focus changing from cost and responsibility centres to strategic business units (SBUs) and value creating activities. Linkages in the traditional system are mainly ignored with the allocation of costs projecting their perceived independent functions, the VC recognises these linkages and attempts to maximise them. VC analysis sees cost drivers as strategic decisions opposed to mere volume measures. The traditional model seems to be more precise, although this is at times questionable, whereas Porters VC is said to display less precision and give indicative answers.Once these have been identified we have to determine the scope for cost reductions. The use of the VC allows us to separate activities into their component parts within an organisation allowing us to achieve a firmer insight into the elements effecting costs. This will enable us to compare differences in the unit costs of competing firms by category in the chain.One must ask however how relevant is the VC, Prahalad of the University of Michigan suggests in his thesis that Porters model is still relevant although it is less significant due to changes in competition within industry.• "Prahalad says companies should cease to be preoccupied with their degree of vertical integration and their own 'value chain' - their various value-creating activities, such as production, marketing and service. Instead they should pay more attention to their ability to create 'virtual integration' by allying with, and purchasing from, competitors. Rather than analysing competitiveness purely on the basis of individual companies,. . ." (LORENZ, 17 DEC 93, London page ) He goes as far as to suggest, that people should realise that the most relevant unit is not the VC but that of 'open clusters' the shifts of networks that form relationships of supply. It seems however that the competitiveness of specific companies will still at the end of the day remain vital. We must ask ourselves if this is true what is the implication for VC.The MA needs to be able to cost VCs both current and in the future of themselves and their competitors . The VC is concerned with the creation and accumulation of value instead of purely concerning itself on the addition of costs and margins.Within organisations there are usually a range of products that are sold to different segments/buyers, the resultant is that behaviour of costs within the chain may vary accordingly. When using VC analysis we must take these differences of cost behaviour amongst segments into account otherwise we run the risk of average costing or incorrect pricing, providing openings for our competitors. (Amat O., Blake J., Gowthorpe C., 1995, p418)There are several problems when using VC analysis in relation to cost effective management firstly is that of the correct allocation of costs within the chain• "Johnson and Kaplan (1987) contend that certain costs are extremely difficult to allocate to certain individual products, but they are the costs of activities which are very significant in relation to total quality and in turn competitive advantage." (Thompson J., 1993 p439) Failures of production equipment are an example of this, effecting a number of products making them late for delivery and causing priorities to change. The problem here is how do we allocate costs? Modern production systems are becoming ever more complex, with this the ratio of overheads to total costs is likely to increase relative to materials and labour. The absolute allocation of these overheads is unobtainable.We need to equate all the costs that are supportive of attributes with revenue produced in the context of the total life-cycle of the merchandises. If a total life-cycle philosophy is not adopted we run the risk of development costs being forgone at the detriment of long term gains in profitability. This exercise needs to be repeated when looking at competition, both in the present and in the future, this does however suppose that information is available regarding competition, product lines and costing structure. Another problem inherent when using VC analysis is that of supposition. We may know how our VC is organised but when it comes down to analysing our competitors the information required is very seldom available to us in it's entirety. As MA's we tend to fill in the gaps with suppositions, these may be correct however it is very unlikely that they will be so in their entirety, there is a danger that these inaccuracies could be magnified and lead to incorrect strategic decisions. For the reasons mentioned in this essay VC analysis should not be seen as a cure all to business costing strategy, The role of the VC however does give us an insight and lays down a useful framework allowing us to consider the activities involved in production of services and products in relation to customer significance.BibliographyAmat O.,Blake J., Gowthorpe C., "Management of accounting The case for an active role", European management journal, (Oxford: Pergamon, vol. 13 no. 4, Dec. 1995)Bowman Cliff, The essence of strategic management, (London: Prentice Hall International (UK) Ltd., 1990)p 62-5Craig James C. ,Grant Robert M., Strategic Management, (London: Kogan Page Limited, 1993)Grant Robert M., Contemporary strategy analysis, Second ed. (Oxford: Blackwell Publishers Ltd., 1995)Lorenz Christopher, FT 17 DEC 93 / Management (Marketing & Advertising): Conventional strategic wisdom takes a knock, London PagePartridge M., Perren L., "Assessing and enhancing strategic capability: a value driven approach", Management Accounting, (June, 1994) p28-29Partridge M., Perren L., "Cost analysis of the value chain: another role for strategic management accounting", Management Accounting, (July/August, 1994) p22-23.Thompson J., "The value chain and competitive advantage", Management awareness strategy and change, 2nd ed. (Chapman & Hall, 1993) 434-439


Companies conduct value chain analysis by looking at every production step required to create a product. The overall goal is to deliver maximum value for the least possible total cost.

There are many advantages of value chain analysis, which all result in a company's ability to understand and optimize the activities that lead to its competitive advantage and high profit levels. The disadvantage of value chain analysis is that it forces a company to break into segments, and there is the possibility of losing the big picture in the details.

Advantages of Value Chain Analysis

The primary goal and advantage of a value chain, and therefore value chain analysis, is to create or strengthen a competitive advantage. Through analyzing the five primary value chain activities, a company can ensure that the value it's creating exceeds the cost to create that value.

The five value chain activities are:

  1. inbound logistics
  2. operations
  3. outbound logistics
  4. marketing and sales
  5. service

If a company can create an advantage in any one of these activities through a value chain analysis, it captures a competitive advantage and increases its overall profit. To capture a competitive advantage, a company maps out its specific activities within the five generic value chain activities and looks for ways to create efficiencies.

Disadvantage of Value Chain Analysis

While there are many advantages of conducting a value chain analysis, the disadvantage of conducting this type of analysis is that sometimes a company's overall strategy and vision is lost when its operations are broken down into segments.

Creating efficiencies in each of a company's value chain activities is important, however, the value chain doesn't do a good job of linking each activity in the chain together. It's possible to lose sight of how the activities relate to each other.

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