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When Sydney Stupp places an employee at a customer's site to help specify and procure nuts and bolts, he saves the client the cost of having his own staff handle what is usually a low-level task. At the same time, by knowing customer needs in advance, Stupp cuts his own marketing and inventory costs.
"We eliminate redundancies in the supply chain so we don't have our people doing work their people are doing," explains the co-owner of industrial distributor Process Products Ltd. in Toronto. "We put the work where it belongs and have one company do it."
What Stupp is doing is changing Process Products' place and role in the value chain--the linkage of activities and processes that create and deliver products and services to customers. Instead of simply playing the role of a distributor between fastener manufacturers and the equipment makers who are his customers, he creates a vertical linkage between himself and his customers.
Similar value chains exist in any industry. Magazines, for instance, reach customers through a value chain consisting of publishers who link to wholesale distributors who are linked to bookstores and newsstands that link to the final customer. Experts say understanding value chains can help entrepreneurs do everything from cutting costs to spotting new opportunities.
"You can look at how to alter the value chain and hopefully capture more value for yourself," suggests David Wilson, a professor of entrepreneurial studies at Pennsylvania State University in University Park. "Or you may be able to replace a longer value chain with a shorter one by removing steps."
Consultant and author Michael Porter introduced the term "value chain" in his book Competitive Advantage (Free Press). Porter urged managers to separate various business activities, such as designing, producing, marketing and distributing, to see how each one impacts costs, helps differentiate the firm's offerings and otherwise affects competitive strategy.
Since then the value chain has acquired some new links. Businesspeople today are told to look at the value chain from the customer's viewpoint and in light of new technologies such as the Internet.
Adrian Slywotzky, founding partner of Boston strategic consulting firm Corporate Decisions Inc., believes that deep understanding and savvy manipulation of the value chain is behind some outstanding recent successes. According to his new book Value Migration (Harvard Business School Press), Microsoft, Wal-Mart and other successful firms became leaders specifically because they saw how value was shifting among links of the chain. Microsoft understood the new importance of courting application software developers, while Wal-Mart grasped the value of absorbing the distribution link into itself.
These value chain success stories are good news for entrepreneurs, says Slywotzky, who sees the current business climate as something of a golden age for entrepreneurs who can create business models that capture excess value. "The business models of the incumbents are becoming obsolete," he explains, "and that's creating more opportunities for small business than have existed for several decades."
The first step in looking at a value chain is to separate your firm into the activities that give it a competitive advantage. Within a company this may include primary activities such as manufacturing, moving goods through your operations, marketing and sales, and service. There are also support activities such as purchasing and human resources management. Porter stresses that everything a firm does should be categorized into some specific activity.
Next, you must analyze the linkages between those activities. This will include studying how various activities affect each other, such as the way scheduling meetings may affect travel costs. Value chain analysts also look for various ways to do the same or similar jobs. Quality control, for example, can be achieved by inspecting finished goods, by using high-quality raw materials or by mandating small tolerances for error.
Once an entrepreneur understands his or her own firm, the value chain should be looked at on an industry basis. In this step, a manufacturer might study values and links between suppliers and customers, in-house and third-party sales forces, outside service providers and competitors.
Entrepreneurs may find they are not making the most of a critical value their firm is adding or that they are failing to provide something customers would value highly. This detailed understanding of the links in the value chain can provide a foundation for improving the performance of an existing firm or for creating an entirely new company.
Quite often, savvy entrepreneurs find that value chains are longer, more complex and less efficient than they could be. Companies that band together to integrate and bundle their product and service offerings can be said to be cutting the value chain in creative and profitable ways. Says Wilson, "A lot of the entrepreneurial process is creating alternative value chains or repositioning value in the chain."
Risks, Limits, and Costs
The value chain has remained popular as a way to look at business while other ideas have come and gone. "It's a very capacious and extraordinarily flexible [concept] and can serve multiple needs," says Alan Kantrow, chief knowledge officer at the Monitor Co., a Cambridge, Massachusetts, strategic consulting company.
It's possible, however, to get tangled up in the value chain. One risk is that an entrepreneur will expend precious resources emphasizing a value that is, in the end, not that valuable. Common mistakes include creating a differentiation that is quickly matched by competitors, aiming to be too many things to too many people, and trying a low-cost strategy that fails to make you the absolute low-cost leader.
In any one of these cases, poor value chain analysis may be worse than no analysis at all. "You have to think very carefully about how you are going to add and create this value to change the system," says Wilson.
Some lessons of the value chain are of little interest to many entrepreneurs. For instance, few small companies possess the resources to become vertically integrated producers themselves, controlling every link in the value chain.
Value chain-based strategies are also only as good as their execution. Process Products has added costs by having employees at customers' sites, as well as investing in technology to tap into customers' electronic ordering systems.
The extra costs have not always been balanced by increased sales, says Stupp. He complains that it's hard to persuade some customers to let his people have access to design specifications. And, without this input, it's hard to produce the promised savings. "If you don't get total cooperation from the client," says Stupp, "you're still fighting the same uphill battle."
Finally, no matter how well Stupp understands his role in the value chain, he has to understand his clients' place just as well, or he won't know how to help them. "We can't cookie-cut our value into every company," cautions Stupp. "We have to look at it very closely to find out what actually adds value."
When all is said and done, however, Stupp has no problem with hanging his company's future on the value chain. He explains that this is a way to add unique value to what is otherwise a low-value commodity. Without manipulating the value chain, he's in for a long, hard run. With it, says Stupp, "we can increase our business exponentially, as opposed to incrementally."
Mark Henricks is an Austin, Texas, writer specializing in business topics.
Corporate Decisions Inc., 100 Oliver St., 1 International Pl., Boston, MA 02110, (617) 330-6890;
Monitor Co., fax: (617) 252-2100;
Process Products Ltd., (905) 433-4770, fax: (905) 433-4013.