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Value Chain Analysis as a Way of Achieving Competitive Advantage
Every organization seeks to gain competitive advantage in its area of operation. Competitive advantage in a given field means the inherent capability to predict, meet, and exceed the customer’s needs profitably, in a competitive environment (Institute of Management Accountants 1). In today’s market the environment consumers can easily access alternatives to a product. This makes attaining competitive advantage as a major organizational challenge. One of the ways in which an organization can achieve strategic advantage is through the streamlining of the value chain. Value chain analysis enables organizations to determine the pros and cons of their value creating processes. This helps assess the operating environment and achieve competitive advantage. This paper seeks to analyze how organizations can use the value chain as a means of strategic organizational analysis.
The value chain stands for the internal processes that an organization undertakes to design, create, market, and convey a product to the consumer (Institute of Management Accountants 1). So how can an organization use this process in analyzing its competitive advantage? To start with is the use of the internal cost analysis.
Internal Cost Analysis
Organizations realize the internal cost analysis by identifying the sources of profitability and understanding the cost of internal processes and activities. Internal cost analysis involves a number of steps.
The first step is the identification of an organization’s value creating processes. To control costs in any value creation process, an organization has to identify such processes in the first place. This means that every processes has to be documentable in a process flow chart from start to end (Institute of Management Accountants 5). Moreover, to achieve results from value chain analysis, organizations need to shift from function based structures to process based structures. A process based organization is one that views different units not as departments but as components of a value addition process from the input stage to the end product sent to consumers. This way, it is easy to analyze which aspect of the process adds the most value to the production process and which one adds the least.
Once the value creation process is visible, an organization can determine the proportion of the total costs implied in each aspect of the process. With costs of all aspects of the value chain quantified, an organization can easily identify the cost drivers in the value creation process (Institute of Management Accountants 5). It is noteworthy that a full-cost approach in apportioning cost is the best choice since looking at individual cost implications might affect product quality for short term nominal gain (Institute of Management Accountants 5).
Once the total cost apportionment is complete, an organization can then identify the cost drivers for each process. A good understanding of cost drivers enables a firm to assign time and resources in cost cutting initiatives. In doing a cost analysis of the cost drivers, it is imperative to understand the factor costs of competitors (Institute of Management Accountants 5). If they are lower, then more needs to be done in cutting internal cost drivers. Failure to do so can reduce overall competitiveness once the finished product hits the market.
Identification of cost drivers is then followed by a determination of the link between the processes. This assists in analyzing where opportunities exist for achieving a cost advantage in the value chain (Institute of Management Accountants 5). Value addition processes are not independent of each other and must be viewed in totality in order to achieve cost advantage. A good example of this is Tandem, an American computer company. Tandem cut its purchase costs by sharing a bar code system with suppliers (Institute of Management Accountants 9). This goes to show that a holistic approach to cost management is the only way; organizations can achieve cost advantage by use of value chain analysis.
Internal Differentiation Analysis
Another way in which the value chain can be used as a means of achieving competitive advantage is through internal differentiation analysis. Differentiation analysis focuses on how customers perceive an organization’s products. In carrying out internal differentiation analysis, a firm has to identify its value creation processes as well as the primary cost driver to the final product cost (Institute of Management Accountants 10). An internal differentiation analysis follows a number of steps.
The first step in making an internal differentiation analysis is to identify the end –users’ value generating processes (Institute of Management Accountants 10). In creating an above par product differentiation strategy, a firm needs to align its value creation processes with the consumers’ value adding processes (Institute of Management Accountants 10). Once these processes are in sync, a firm seeking competitive advantage through differentiation can evaluate differentiation strategies for enhancing customer value. To succeed in this, an organization needs to come up with value addition processes which are dissimilar to those of competitors (Institute of Management Accountants 10). There ways to achieve this goal are represented below:
1. Product merits: An organization can either choose to create products of visual appeal, or products of superior quality (Institute of Management Accountants 11). A good example of this is the automaker BMW. Anytime a person hears the name BMW, they associate these cars with high quality cars. In essence therefore, BMW has successfully managed to create its brand, using a superior function differentiation strategy.
2. Marketing networks: An organization seeking competitive advantage through differentiation needs to come up with superior marketing channels. Such channels need to provide an acceptable level of receptiveness, expediency, diversity, and information different from competitors (Institute of Management Accountants 11).
3. Amenity and support: The ability to respond to consumer product queries can offer an organization a differentiating advantage amongst competitors (Institute of Management Accountants 11). IBM is an example of an organization that has built its market using this differentiation technique. The company’s ability to provide customer support for mainframe computers in the 1980s created a lasting impression in the minds of consumers.
4. Brand positioning: The image which an organization postulates to the public is very important. It is critical to sell the right image, which is also different from that of competitors (Institute of Management Accountants 11). For instance, American Express has managed to maintain its market share over the years, thanks to the image of quality of its services. The company’s brand image also enables it to sell its services at a premium, which impacts positively on its bottom-line.
5. Price: A product that affords consumers the ability to save a coin and thus differs from the competitors’ gains an edge in the market. In pursuing differentiation as a means to competitive advantage, it is essential to price products right (Institute of Management Accountants 11). The price should be lower than that of competitors. In case the consumers have to pay a higher price, it must be accompanied by superior quality, relative to what competitors have to offer. A good example of this analogy is American Express. The company operates in the highly competitive financial services industry. However, by offering superior services plus a strong brand image, the company is able to charge a premium and stay a notch higher relative to competitors.
Lastly, an organization can use the value chain as a means for analyzing strategic advantage, through vertical linkage analysis.
Vertical Linkage Analysis
Achieving competitive advantage goes beyond streamlining internal processes. An organization needs to create linkages between its value creating processes to those of its suppliers, distribution channels, and consumers (Institute of Management Accountants 13). In doing a vertical linkage analysis, an organization needs to consider all links from the source of production materials to the discarding and re-use of the finished consumer product. According to Shank and Govindarajan in their 1993 work, understanding the vertical chain is important because it enables a firm to understand its cost and differentiation position relative to other players in the food chain (Institute of Management Accountants 13). This is because every participant in the chain (from suppliers, distributors, and consumers) has profit precincts, which if overlooked, is able to make an organization lose its competitiveness.
Moreover, a vertical linkage analysis can help an organization determine which activities are most important for maintaining competitive advantage. The Swiss watch industry proves the importance of vertical linkages. Swiss watch makers commanded the market until low priced watches from other countries flooded the market in the 1970s (Institute of Management Accountants 14). The Swiss watch industry responded by mass producing watches but to no avail. Swiss companies failed to realize that their problems were not rooted in the internal organizational efficiency but in the quality of their distribution channels. Distributing Swiss made watches was very expensive relative to watches from other countries. Once the Swiss watch industry rectified the problems in distribution, they regained their market dominance, thanks to a superior watch quality.
To carry out a successful vertical chain analysis, it is imperative to identify the industry value chain and assign costs and revenues based on industry value creating activities (Institute of Management Accountants 14).
However, it is critical to note that quantifying an industry value chain can be a daunting task. This is because there are companies which partake the whole industry value chain, while others only concentrate on certain aspects of an industry. A good example of this is the petroleum industry. The vertical chain of petroleum production encompasses exploration, mining, refining, promotion, and circulation (Institute of Management Accountants 14). In this industry, big players like BP, Shell, and Total control the process from exploration to distribution. On the other hand, small players partake in one or several aspects of this industry. This makes it difficult for an organization to apportion industry costs as the industry is largely controlled in-house.
In spite of this challenge, an organization seeking competitive advantage needs to understand the industry value chain, apportion total costs, identify cost drivers, and seek to produce on the mot efficient way relative to competitors (Institute of Management Accountants 15).
Works cited
Institute of Management Accountants. “Value Chain Analysis for Assessing Competitive
Advantage.” Practice of Management Accounting. (1996). < http://www.imanet.org/PDFs/Public/Research/SMA/Value%20Chain%20Analysis.pdf>