Generally speaking, value chain analysis typically includes two types of ventures:
Firm value chain analysis (often referred to as Porter Value Chain Analysis)
examines internal company practices and their optimization relative to creating value for customers.
Industry value chain analysis involves examining the various stages of a product’s production,
from raw material procurement all the way through the final purchase by end-users.
While internal analysis can be a helpful tool for improving margins, industry-wide analysis can
assist companies with a broad range of business-critical activities, such as evaluating and
planning potential mergers and acquisitions, exploring new markets and improving competitive
positioning, in addition to profit margin optimization. For our discussion, we will be focusing
on industry value chain analysis.
Understanding the Industry Value Chain
A value chain includes profit and cost considerations for each step in a product’s lifecycle,
including raw material sourcing/production, manufacturing concerns and the characteristics of
the final sale to end-users. During value chain analysis (VCA), each step (or “node”)
of a product’s value creation is evaluated. These examined nodes include factors such as
the sourcing of raw materials, costs associated with production and distribution, and the
characteristics that drive customers’ willingness to pay for the final product. Qualities
of each node impact the total costs and expected margins of the final delivered product.
VCA is often used to identify opportunities for increased profit through the recognition
of more effective cost control, pricing, product positioning and/or distribution strategies.
At each node of the value chain, market participants are actively producing goods or offering
services, while simultaneously making numerous choices that directly affect their profit margins.
Industry Value Chain Example
The various nodes of a value chain are often best summarized graphically.
Below you will find an introductory example of a value chain process for the production of a
common food item (ice cream).
In this case, the VCA details the profitability at several different nodes in the ice cream
sales process, from raw material (dairy, sugar, flavorings) production, product manufacture,
distribution and the final retail sale to the consumer. At each node, market participants
experience unique cost and price considerations, and perform activities that add value above
the material and labor inputs utilized, yielding varying gross profit margins.
Whether assessing the potential acquisition of a competitive firm or exploring backward
integration up the supply chain, understanding the value chain dynamics of your market is key
to success. Upstream nodes of the value chain, such as raw material supply, may have unknown
costs or be vulnerable to market fluctuations (trade tensions, unforeseen weather events, plant
closures, etc).
Further, examining the factors that drive production costs can aid estimations of the potential
benefit of mergers and acquisitions, particularly if the goal is to invoke economies of scale.
These market dynamics are often unknown to downstream manufacturers, and can be revealed when
the entirety of the value chain is evaluated in total.