Value chain analysis looks at the things that are most valuable to a company and helps improving in those key areas. This is just like you planning a party!
For anyone who has planned a party, you know you have to think of several different factors. You have to think about location. You have to think about how much money you want to spend and other things like how many people to invite. You also have to pick out a date when you're going to have your event.
What if you are limited on funds?
Next you might want to invite other people in to assist you, or change what you're spending. Instead of ordering that lobster and that really expensive food, maybe you want to just have burgers and fries. That may mean adjusting your budget. If you lower the amount of money that you spend, that means that you're going to be able to invite more people. This is a similar concept to value chain analysis.
To understand value chain analysis, you have to see it as a way to strategize or really think hard about how you're spending.
With value chain analysis, there are a lot of meetings that take place in boardrooms and conference rooms as companies want to think about how they're going to budget their money. They might throw around words like allocate funds, which is the same thing as how they're going to spend money and distribute it.
What value chain analysis actually does is that it looks at the things that are most valuable to the company and helps to improve in those key areas. This is just like you planning that party.
What’s important to us for a successful party?
You might ask yourself what is the most important thing that you want to achieve with the party? Maybe you want to spend the most money on the cake and decorations. That means you have to make sure that someone prepares the food so that you can focus the money and everything else. With value chain analysis, it's a similar method.
A company's goal is to try to make sure that it performs in different areas better than another competitor might. For example, Netflix might have better videos than Amazon Prime. Because Netflix offers a larger variety, people want to watch Netflix videos more. If Netflix decided to add video games, they have to check to make sure that they will make more money. If for example, Amazon Prime also started allowing the rental of video games, they might be able to compete with them – and keep up. Then Netflix would have to look at the cost advantage to see if they are indeed making more money and should stay with video gaming or just go back to videos.
This value chain analysis strategy is something that Netflix actually did. You might not remember it, but a few years ago, you could actually order DVDs through Netflix and have them sent to you in the mail. Netflix switched over to online videos and streaming content when they changed their mind about how much money they were losing on mailing those DVDs back. They changed because they saw so much money that was being made in profit from having streaming content, they cut back on their DVD service. People also saw this as an old way to watch movies and Netflix had to keep up with the competition.
The benefits of the value chain analysis are that it's going to help a company to produce more goods and services. They can do this with store operations, and other departments like transportation, marketing sales, and service. This is the primary category area. When we start to talk about the subcategories, it can be two firms in the structure, the IT or technology department, compliance, as well as human resource management and personnel or administrative staff. The subcategories help to support the primary goals of the company.
Are you ready for a Quick Pop Quiz?
Question: What is the ultimate goal of the company?
Answer: To make a profit and not just profit, but to make the most profit by spending the least amount of money in the most honest and ethical (legal) way.
Because the company may want to strategize and that means all of those big meetings to see where they can cut money. They may need to discuss how to save money in areas like shipping, staffing and transportation. Remember when we mentioned that Netflix would send the DVDs in the mail? That's part of logistics, too. Remember, logistics is transportation and shipping. That may have been one area where they said they were wasting too much money in stamps and sending free stamped envelopes back and forth in the mail.
Other areas that can be strategic for a company include sales. Netflix, for example, when streaming content picked up, they started running a lot of sales ads for monthly plans. They ran specials where you could get all the movies you wanted for $7.99 a month. Because they were able to target the right market, they made a lot of money.
As soon as they came out with an email blast to already happy customers that they were going to raise rates, all of their customers complained and decided to leave. That’s big because it’s bad news for profits. This type of example is what happens when the company thinks they have a cost advantage, but, in this case, Netflix was wrong.
What if you miscalculated your value chain analysis as it related to sales?
That could happen to you with that party planning example that we opened with.
Let's just say you invite 100 people to the party. Because you spent so much money on the cake you might not have enough food to feed 100 people. They might complain and not show up (that means wasted food) and the next time you have a party they might ignore you. For a business like Netflix, you guessed it – a loss of sales, a loss of profits, too. That's why you have to strategize and make sure you get a head count if you’re planning a party and the right cost analysis if you’re setting target prices with your products or services in your business.
Just keep in mind with value chain analysis that it's about adding as much value as you can to a final product. You want to make the most money and get the most profit by spending the least amount of money, honestly. That means order a cheaper cake and invite more people. But don't tell that plan of yours to people that you’ve invited to the party or they may not show up!
Reference:
http://www.strategicmanagementinsight.com/tools/value-chain-analysis.html
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