• Transforming the value chain

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    CARLO ARMIN CLARO

    CARLO ARMIN CLARO

    When the new administration presented its proposed 10-point socioeconomic agenda, the term “value chain development” caught my attention. The new administration recognizes that developing a good value chain can contribute to fostering inclusive growth.

    The concept of value chain was first introduced by Michael Porter, a Harvard Business School Professor, in 1985 in his influential book, “Competitive Advantage”. Value chain is a set of activities performed to design, produce, market, deliver, and support products that an organization creates to generate value for the customer, as defined by the customer. The more value the chain creates, the stronger a company’s competitive advantage becomes.

    Porter describes two major categories of business activities: the primary activities, which are directly involved in transforming inputs into outputs, and in delivery and after-sales services. Classic examples of these activities for a manufacturing firm, as provided by Porter, are:

    • Inbound logistics—activities pertaining to receiving, storing, and distributing inputs internally

    • Operations—transformation of inputs into outputs or final product or service

    • Outbound logistics—activities pertaining to order processing and distribution

    • Marketing and sales—activities aimed at persuading customers to choose your products over the competition, e.g., communication, pricing and channel management

    • Services—activities a company provides after sales in order to maintain value of the products or services to customers.

    The secondcategory is the support activities, which support the function of the primary activities. These include the following:

    • Procurement/purchasing—activities to get the resources a company needs to operate

    • Human resource management—refers to policies, practices, and systems that influence employees’ behavior, attitudes, and performance

    • Technological development—activities related to managing and processing information needed in every value chain activity

    • Infrastructure—anagement, accounting and finance

    Value chain varies depending on the business model and the activities that generate value for the organizations’ product or services.

    With the constantly changing business environment, the value chain should be flexible enough to respond quickly to the change. More advanced technologies and changing customers’ preferences allow new entrants to remove low-value stages or shift stages to different types of participants and seize economic benefits for themselves and their customers. Value chain analysis should, therefore, be considered as part of an organization’s initiatives to gain or maintain the edge on competition.

    The analysis can be done by identifying sources of profitability and determining the cost of internal processes or activities. This is called the internal cost analysis value chain approach.

    The main steps in doing internal cost analysis are:

    • Identify the company’s value-creating processes or value stream mapping of primary activities and secondary activities.

    • Determine the portion of the total cost of the product or services attributable to each value creating process. This establishes the relative importance of each activity in the total cost of product or services.

    • Identify the cost drivers for each process.

    • Identify the links between processes.

    • Evaluate the opportunities for achieving relative cost advantage or reducing cost.

    This kind of analysis mightgenerate a long list of activities. In selecting what to prioritize, the company can perform activity based costing (ABC) by arranging the activities from highest priority to lowest priority based on the cost allocated. The company can then apply the Pareto Principle, and assume that 20% of the total activities could be the significant cost drivers in the chain.

    The other value chain approach is the internal differentiation analysis. This approach is used to identify opportunities for creating and sustaining perceived value of the products or services by understanding the sources of differentiation. As with internal cost analysis, this approach requires the company to first identify its value-creating processes and primary cost drivers. Afterwards, the company should follow these guidelines:

    • Identify the customers’ value-creating processes by focusing on activities that contribute the most to creating customer value.

    • Evaluate differentiation strategies for enhancing customer value by either enhancing or adding product features, marketing channels, brand positioning, service and support, or pricing.

    • Determine the best sustainable differentiation strategies.

    In a publication entitled, “Shorten the value chain: Transforming the stages of value delivery,” Deloitte addressed some key questions on transforming the stages of value delivery.

    Are there a significant number of stages in my value chain?

    Markets with extended value chains that have a relatively high number of stages are often vulnerable to disruption. This is because long value chains imply that incumbent suppliers, producers, or designers may be several steps removed from the customer, and thus receive less insight into customer needs and market dynamics. Additionally, long value chains may be slower to respond to changing customer preferences due to the high number of inputs and extensive coordination across parties that will be required to address any changes. Conversely, value chains with few stages will be able to swiftly adapt and adjust to customer demands and preferences.

    Do I rely on third parties or complementary product offering to deliver value to customers?

    Businesses that rely heavily on intermediaries or other products are vulnerable to changes in their ecosystem that are out of their control. If a complementary product or intermediary exits the market, expands capabilities, or renders a portion of the value chain obsolete, incumbents may find themselves unable to compete in the market. Conversely, businesses that are fully independent control their own place within the market, can more swiftly adapt to changes in customer needs, and are able to adopt new technologies with less resistance.

    Does my product/service have a high lifetime total cost of ownership?

    When products or services have high cost of ownership, customers with low switching costs will be eager and inclined to look for cheaper alternatives. Entrants may be able to capitalize on this by addressing one of the many factors behind the high prices. When new players are able to decrease costs by removing steps or players from product creation through consumption, offerings become enticing to buyers.

    It is worth noting that before embarking on any initiative to improve the value chain, the company should be clear on what it is trying to set apart from the competition. The value chain should reflect the overall strategy of the company, whether it be low cost, differentiation, focus, or a combination of any of the three strategies. The main goal is not just to have a competitive advantage but a sustainable competitive advantage that brings with it sustainable growth.

    No doubt this is what the current administration hopes to achieve in including the promotion of rural and value chain development in its economic agenda. Let’s hope it succeeds in this endeavour so that more and more Filipinos can finally feel what it’s like to have one of the fastest growing economies in Asia.

    The author is a Director with the Audit & Assurance division of Navarro Amper & Co., the local member firm of Deloitte Southeast Asia Ltd., a member firm of Deloitte Touche Tohmatsu Limited—comprising Deloitte practices operating in Brunei, Cambodia, Guam, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam.

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