Value Chain Analysis
Value Chain Analysis
Value Chain Analysis
TITLE
CREDITS
This statement was approved for issuance as a Special thanks are due to Randoif Holst, SMAC
Statement on Management Accounting by the Manager, Management Accounting Guidelines, for his
Management Accounting Committee (MAC) of the continuing project supervision and to the members of
Institute of Management Accountants (IMA). IMA appre- the focus group (including MAC members Dennis Daly
ciates the support of The Society of Management and Thomas Huff) for contributing to the improvement
Accountants of Canada (SMAC) in helping create this of the final document.
SMA and extends appreciation to Joseph G. San
Miguel, of the Naval Postgraduate School, who drafted
the manuscript.
TABLE OF CONTENTS
I. Rationale . . . . . . . . . . . . . . . . . . . . . . . 1 Exhibits
II. Scope . . . . . . . . . . . . . . . . . . . . . . . . . 1 Exhibit 1: The Value Chain . . . . . . . . . . . . . .3
III. The Value Chain Defined . . . . . . . . . . . . .1 Exhibit 2: Competitive Advantage Through
IV. Competitive Advantage and Low Cost and/or Differentiation . . .4
Customer Value . . . . . . . . . . . . . . . . . . .2 Exhibit 3: Process Cost Drivers . . . . . . . . . . .8
V. The Role of the Management Exhibit 4: Competitor Cost Analysis . . . . . . .10
Accountant . . . . . . . . . . . . . . . . . . . . . . .4 Exhibit 5: Value Chain for Crown, Cork
VI. The Value Chain Approach for and Seal Company . . . . . . . . . . .12
Assessing Competitive Advantage . . . . . .5 Exhibit 6: Vertical Linkages in the Production
Internal Cost Analysis . . . . . . . . . . . . . . .5 of Plastic Food Containers . . . . . .13
Internal Differentiation Analysis . . . . . . .10 Exhibit 7: Value Chain Differences: The
Vertical Linkage Analysis . . . . . . . . . . . .13 Telecommunications Industry . . . .16
VII. Strategic Frameworks for Exhibit 8: How Tetra-Pak Reconfigured
Value Chain Analysis . . . . . . . . . . . . . . .17 the Value Chain . . . . . . . . . . . . .21
Industry Structure Analysis . . . . . . . . . .18 Exhibit 9: How IKEA Reconfigured the
Core Competencies Analysis . . . . . . . . .19 Furniture Industry . . . . . . . . . . . .22
Segmentation Analysis . . . . . . . . . . . . .22 Exhibit 10: Approaches to Defining
Segmentation Variables . . . . . . . .24
VIII. Limitations of Value Chain Analysis . . . .26
Exhibit 11: Segmenting the British
IX. Organizational and Managerial
Frozen Food Industry . . . . . . . . . .25
Accounting Challenges . . . . . . . . . . . . . .27
Exhibit A-1: Value Chain vs. Conventional
X. Conclusion . . . . . . . . . . . . . . . . . . . . .28
Management Accounting . . . . . . .30
Appendix – Value Chain Analysis vs. Conventional
Management Accounting
Bibliography
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E X H I B I T 1 : T H E VA L U E C HA I N
EXHIBIT 1. THE VALUE CHAIN
Primary Support
Activities Activities
R&D
End-Use Consumer Pays for Profit Margins Throughout the Value Chain
Supplier
Value Chain Procurement
Design
Firm Z
X Y Value Chain Technology
Development
Production
Distribution Human
Value Chain Resource
Management
Marketing
Buyer
Value Chain Firm
Infrastructure
Distribution
Disposal/
Recycle
Value Chain
Service
relative cost advantage enables a business to channels or customers: and superior operating
do one of two things: price its product or service management. A company might also gain a
lower than its competitors in order to gain market relative cost advantage by exploiting economies
share and still maintain current profitability; of scale in some markets.
or match the price of competing products or
services and increase its profitability. The relationship between low-cost advantage and
differentiation advantage is illustrated in Exhibit 2.
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EXHIBIT 2: COMPETITIVE ADVA N TAG E THRO UGH
LOW COST AND/OR D IFFERENTI ATION
EXHIBIT 2. COMPETITIVE ADVANTAGE THROUGH
LOW COST AND/OR DIFFERENTIATION
Superior
Differentiation Differentiation
Advantage with Cost Advantage
Relative
Differentiation
Position
Inferior
Inferior Superior
Superior relative cost position offers equivalent distribution channel; profit variance analysis;
customer value for a lower price. Superior relative and financial analysis.
differentiation position offers Source:
betterShank,
customer
and Govindarajan, 1993.
value for an equivalent price. Today, management accountants must also bring
skills in activity-based costing, benchmarking,
Organizations that fail to gain competitive re-engineering, target costing, life-cycle costing,
advantage through low cost or superior differen- economic value analysis, total quality manage-
tiation, or both, are “stuck-in-the-middle.” For ment and value chain analysis. The Appendix
instance, several American bicycle makers, contrasts traditional management accounting
including Schwinn, Huffy, Murray and Columbia, with the requirements of value chain analysis.
found themselves in this position during the
1980s. These companies lacked a cost advantage Value chain analysis is a team effort.
and failed to foresee the emerging mountain Management accountants need to collaborate
bike market. By contrast, Cannondale captured with engineering, production, marketing, distribu-
market share after introducing its large-diameter tion and service professionals to focus on the
frame bicycle. strengths, weaknesses, opportunities and threats
identified in the value chain analysis results.
V. T H E R O L E O F T H E
M A N A G E M E N T A C C O U N TA N T By championing the use of value chain analysis,
The management accountant is traditionally con- the management accountant enhances the
sidered the resident expert on cost analysis; firm’s value and demonstrates the value of the
cost estimation; cost behavior; standard cost- finance staff to the firm’s growth and survival.
ing; profitability analysis by product, customer or
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Processes are structured and measured sets of United Airlines has failed to match American’s
activities designed to produce a specified output installed base of terminals in travel agencies.
for a particular customer or market. Emphasizing
process means focusing not on what work is done Determine the portion of the total cost of
but on how work is done within the organization. the product or service attributable to each
value-creating process.
While an organization’s hierarchical structure The next step of internal cost analysis is to trace
typically lays out responsibilities and reporting or assign costs and assets to each value-creating
relationships, its process structure shows how process identified. Although firms maintain internal
the organization delivers customer value. While reports and cost accounting information, this
it is not possible to measure or improve hierar- information may not align with their processes.
chical structure in any absolute sense, processes Companies might have to reclassify their data or
lend themselves to such measures as cost, conduct cost studies to assign costs and assets
time, output quality and customer satisfaction. to each process. Rather than conduct a detailed
cost study, an organization might use rough esti-
Because processes normally cut across func- mates to assign costs to their value-creating
tional areas, defining process boundaries is not processes.
always a straightforward task. People associated
with a particular business process may view it in A full-cost approach provides the best estimate
different ways. For example, the new product of life-cycle costs for evaluating the strategic
development process could start with marketing cost advantage of a firm’s value-creating
surveys or with delivery of product requirements process. Without adopting this approach, a firm
from marketing to development engineering. The risks sacrificing product development costs to
process could end with the release of product short-term profits.
specifications or with shipment of the first order.
Process boundaries should be defined independ- For example, the savings in factory labor that an
ently of the way in which activities are organized. organization gains through using flexible manu-
facturing systems, robotics and computer-
Selecting the appropriate activity category may integrated manufacturing might be offset by the
be anything but straightforward. The key is to high cost of computer software programmers.
classify value activities according to their true The information systems support costs should
contribution to the firm’s competitive advantage. be allocated to the value-creating processes
For example, if order processing is important to that benefit from the new systems as part of
a firm’s customer interactions, then this activity the full cost.
should be classified under marketing.
For estimating the full cost of each value-creating
Management at American Airlines, for example, activity, the full utilization of the capacity of
handed its marketing unit the task of developing the activity or its practical capacity is normally
and implementing the carrier’s SABRE computer- used. Facility managers and equipment vendors
ized reservation system. The result: a significant are useful sources of capacity estimates. If
competitive advantage that left the other airlines estimates of full capacity vary widely, a firm
scrambling to copy the system. Even mighty could perform the analysis with the resulting
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costs to assess the sensitivity of the analysis to Structural cost drivers consist of organizational
the different capacity measures. When costs factors that determine the economic structure
vary dramatically, companies should seek more driving the cost of a firm’s products. These cost
information for a more realistic long-term drivers reflect a firm’s long-term decisions, which
estimate of capacity.1 position the firm in its industry and marketplace.
Structural cost drivers may change.
Although many of the processes identified may
be instrumental for achieving competitive advan- For example, large pharmaceutical companies
tage, various value-creating processes may have enjoy economies of scale that lower their unit
differing effects on a firm’s costs or products. costs for expensive R&D. Elsewhere, Texas
Companies selling pencils, pens or paper clips, Instruments has exploited the experience curve in
for example, are unlikely to concern themselves lowering its life-cycle product cost. However, bigger
with after-sales service. But customer support is not necessarily better, as evidenced by the
is a vital part of the competitive strategy for success of steel companies’ mini-mill strategy.
makers of computers or high-speed copiers.
Executional cost drivers capture a firm’s opera-
Identify the cost drivers for each process. tional decisions on how best to employ its
The next step of internal cost analysis is to identify resources to achieve its goals and objectives.
the factor or cost determinants for each value- These cost drivers are determined by manage-
creating process. By understanding what factors ment policy, style and culture. How well a firm
drive costs, a firm can assign priorities among its executes its use of human and physical
cost improvement initiatives. In order to determine resources will determine its level of success or
its relative cost advantage, a firm should also failure. For example, worker empowerment and
know the cost factors of its competitors.2 flattened organizations are helping many firms in
their continuous improvement efforts.
While management accounting systems may
contain the total cost of each value-creating Few structural and executional cost drivers can
process, they may not reveal the causes or factors be operationalized under existing management
for the significant individual costs. Using single accounting systems in the cost analysis of the
output or volume measures (e.g., units, labor hours, value chain. However, these cost drivers do offer
sales dollars) to assign costs is often misleading. an important reminder of the strategic decisions
Multiple cost drivers usually provide more useful that firms need to make, or at least acknowl-
information. Exhibit 3 illustrates examples of edge, in designing their value-generating systems.
structural and executional cost drivers. Increasingly, companies are using activity-based
costing to understand the resources/costs
consumed by the activities and processes used
in delivering their products and services.
1 The reader should refer to IMA’s Statement on Management
Accounting, “Measuring the Cost of Capacity,” for
additional information regarding the various approaches used
for measuring capacity.
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Experience or learning How often has the firm already done this?
Linkages with suppliers and customers Is the linkage with suppliers and
customers exploited, according to the
firm’s value chain?
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Identify the links among processes. efficient at insignificant activities, but to better
While individual value activities are considered meet customer demands.
separate and discrete, they are not necessarily
independent. Most activities within a value chain Using the value chain approach, a company goes
are interdependent. Firms must not overlook beyond simple across-the-board cuts and
value chain linkages among interdependent attempts to lower cost and improve efficiency
activities that may impact their total cost. within each value-creating process. For instance,
a company might negotiate lower costs of
For example, cost improvement programs in one process inputs such as wages or purchases, or
value chain process may lower or increase costs evaluate make-or-buy options.
and/or revenues in other processes. Transfers of
goods and services from one value chain Reducing process input costs often means nego-
process to another increases cost. Eliminating tiating lower wages (as with Chrysler and the
these transfers reduces the costs of purchasing, U.S. airlines during the mid-1980s) or moving
invoicing and other recordkeeping functions. production to countries with cheaper labor costs.
Suppliers might be willing to drop their prices if
Tandem Computers eliminated its costs of the company negotiates long-term contracts, an
purchase orders, invoicing and other functions by approach used by Levi-Strauss in contracting
jointly developing a detailed bar code process with its textile suppliers. Companies also use
with its suppliers. By improving its upstream buyer-seller partnerships to gain advantages in cost,
design and engineering processes for the quality, time, flexibility, delivery and technology.3
Taurus, Ford saved on downstream production
and customer service costs. Using fewer floppy United Parcel Service (UPS) outsourced its
drives and motherboards in its PCs has enabled customer service centers. In the process, the
IBM to halve its delivered cost in two years. company consolidated 65 customer service
centers representing 5,000 jobs down to
As sources of competitive advantage, these rela- between eight and 10 service centers run by
tionships or linkages among activities can be as contractors. UPS service center employees
important as the activities themselves. Such earn $10 to $12 an hour versus the $6.50 to
linkages may also offer sustainable competitive $8 an hour paid to contractors.
advantage, because their subtle, complex nature
makes them difficult for competitors to imitate. Some processes may offer more opportunities
for improvement than others. In order to get the
Evaluate the opportunities for achieving most out of its cost reduction programs, a com-
relative cost advantage. pany should prioritize its value-creating process-
In many organizations, cost reductions are made es. Under the 80:20 rule, 20 per cent of the
across the board (e.g., “eliminate 10 per cent value-creating processes often accounts for 80
from every department”). Because these firms per cent of total costs.
do not reduce their costs strategically, this effort
usually fails. More often than not, across-the-
board cost reduction misconstrues the underlying 3 For more information on buyer-seller partnerships, the
reader should refer to The Society of Management Accountants
problem. The point is not to become more of Canada’s Management Accounting Guideline #32,
“Building Buyer-Seller Partnerships.”
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E X H I B I T 4 : C O M P E T I T O R C O S T A NA LY S I S
EXHIBIT 4. COMPETITOR COST ANALYSIS
Less-skilled labor
Labor
Labor Lower compensation
More specialization
Variable Shop & productivity 7%
and SG&A Variable Shop
and SG&A Scale offset by larger
advertising expenses 0%
Fixed Shop
and SG&A Fixed Shop
Higher utilization of
and SG&A
equipment & facilities 5%
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Identify the customers’ value-creating this unique service to a customer also enabled
processes. P&G to improve its on-time delivery of ordered
To pursue a superior differentiation strategy, a merchandise;
firm’s processes must enhance those of its ● service and support—tailored to end-user and
customers. Thus, a firm should carefully study channel member sophistication and urgency of
the value-creating processes of its customers. need. For several decades, superior service
Exhibit 5 presents such an analysis for Crown, capabilities and high vendor switching costs
Cork and Seal Company (CCS), a metal can maker, produced by proprietary architecture and soft-
and its customers in the late 1970s. The metal ware enabled IBM to build and maintain a
container industry was characterized by low commanding leadership position in the main-
growth, low profits and intense competition. CCS frame computer industry. Until open systems
succeeded with a differentiation strategy, which appeared in the mid-1980s, risk-averse cus-
is usually very difficult to accomplish in a tomers were reluctant to make large capital
commodity-type business. Two different groups and conversion outlays for mainframe computer
of customers—food and beverage canners— systems without the manufacturer’s strong
accounted for 80 per cent of the metal containers assurance of reliability;
produced. ● brand or image positioning—that lends greater
appeal to the company’s offerings on critical
Evaluate differentiation strategies for selection criteria. For many years, this quality
enhancing customer value. image has allowed the American Express Co.
The key to successful differentiation under the to command a significant price premium in the
value-chain approach is to identify the value-creat- highly competitive financial services market—
ing processes that distinguish a firm’s products or a premium that reflects, in its words, the
services from those of its competitors. In making “privilege of membership”; and
this distinction, customer value is emphasized. ● price—including both net purchase price and
cost savings available to the customer through
The ways customer value can be enhanced the use of the product and service.
through differentiation include:
Determine the best sustainable differentia-
● product features—that are esthetically appeal- tion strategies.
ing or functionally superior. For example, the For a firm to achieve superior differentiation, it
Mercedes-Benz automobile accomplished this must utilize the best mix of resources in creating
feat so well for years that its name became value for its customers. In order to prioritize
synonymous with the highest level of quality— its processes as sources of differentiation, a
people would describe a product as the company must determine what attributes of
“Mercedes-Benz” of its category; each process enhance customer value.
● marketing channels—that provide desired
levels of responsiveness, convenience, variety The more unique a firm’s resources and skills,
and information. By placing its order-entry com- the more sustainable is its differentiation advan-
puters in Wal-Mart’s stores, Procter & Gamble tage over competitors.
significantly reduced the overall order-entry
and processing costs for both firms. Providing
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EXHIBIT 5: VALUE CH AIN FOR CROW N, C ORK AND SEAL COMPA NY
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Inventory Holding
Inventory Holding
Supplies of Steel
Manufacturing
& Aluminum
Distribution
Distribution
Purchasing
Purchasing
Processing
Marketing
Canning
Support
Sales
1. Designing distinctive cans for customers may assist their own marketing activities.
2. Consistent can quality lowers customers’ canning costs by avoiding breakdowns and
holdups on their canning lines.
3. By maintaining high stocks and offering speedy delivery, customers can economize on their
own stockholding (they may even be able to move to a just-in-time system of can supply).
4. Efficient order processing can reduce customers’ ordering costs.
5. Capable and fast technical support can reduce the costs of breakdowns on canning lines.
Adapted from: “Crown, Cork and Seal Company and the Metal Container Industry,” and
“Crown, Cork and Seal Company, Inc.” Havard Business School, 1978.
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CCS (Exhibit 5), for example, focused only on Vertical Linkage Analysis
tin-plated steel can production, not aluminum; Linkages among value-creating processes do not
produced for beverage and aerosol customers, not end with the activities within a firm. The greatest
food processors; and invested in more can-forming competitive advantage may come out of linkages
lines at its plants to reduce changeovers and between a firm’s value-creating activities and
set-up wages. CCS was also willing to devote more those of its suppliers, channels or users.
resources to customizing metal containers for
customers and to increase its responsiveness to Vertical linkage analysis is a much broader appli-
customers’ schedule and quality needs. cation of internal cost and differentiation analysis
that includes all upstream and downstream
The payoffs for effective differentiation, and the value-creating processes throughout the indus-
penalties for not differentiating, are clear. In try.Vertical linkage analysis considers all links
1980, Purolator Courier was bigger than Federal from the source of raw materials to the disposal
Express; today the reverse is true. In 1982, and/or recycling of the product. Exhibit 6 out-
Dreyfus had more assets under management lines the vertical links involved in the production
than Fidelity—a situation that had reversed itself of “fast food” containers.
by the mid-90s.
EXHIBIT 6: VERTICAL LINKAGES IN THE PRODUCTION OF
PLASTIC FOOD CONTAINERS
EXHIBIT 6. VERTICAL LINKAGES IN THE PRODUCTION OF
PLASTIC FOOD CONTAINERS
Ethane producers
Styrene producers
Polystyrene producers
Final consumers
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Shank and Govindarajan (1993) state the Vertical linkage analysis includes the following
importance of vertical linkages: steps:
...gaining and sustaining a competitive advan- ● identify the industry’s value chain and assign
tage requires that a firm understand the entire costs, revenues and assets to value-creating
value delivery system, not just the portion of the processes;
value chain in which it participates. Suppliers ● diagnose the cost drivers for each value-creating
and customers and suppliers’ suppliers and process; and
customers’ customers have profit margins that ● evaluate the opportunities for sustainable
are important to identify in understanding a competitive advantage.
firm’s cost/differentiation positioning, because
the end-use customers ultimately pay for all Identify the industry’s value chain and
the profit margins along the entire value chain. assign costs, revenues and assets to
value-creating processes.
Vertical linkage can reveal which activities are Because vertical linkages can be complex
the most (and least) critical to competitive and intangible, they are often overlooked by
advantage (or disadvantage). For example, Swiss organizations. For example, the petroleum
watchmakers succeeded for years as relatively industry consists of numerous value-creating
small, labor-intensive assemblers. Then came processes or activities, including exploration,
the 1970s and the advent of low-cost, mass- production, refining, marketing and distribution.
produced watches. The Swiss responded by These processes define the value chain for this
restructuring their industry to gain economies of industry. One company may participate in all
scale similar to those enjoyed by their new parts of this value chain; another firm may
global competitors. participate in only a few. This diversity of opera-
tions and organizations makes it difficult to
However, the Swiss failed to realize that their adopt a standard approach for identifying
critical problem was not in manufacturing. This industry value chain processes.
set of activities added only a small proportion of
the value of their final product. Far more significant Few firms have information systems that can
were downstream activities in output logistics, identify and analyze these subtle relationships.
marketing, sales and service. Beyond being able For example, profitability and return on assets
to make a watch cheaply, the Swiss had to lower are key measures of competitive advantage
their costs of distribution and service. They throughout an industry’s value chain. It can be
came up with the hugely successful Swatch, extremely difficult to obtain pertinent information
which, besides being inexpensively priced, was for these measures, including operating costs,
virtually indestructible and could be distributed revenues and assets for each process through-
through numerous low-cost channels, from out the industry’s value chain. However, this
department stores to discount houses. information is necessary to calculate a rate of
return on assets for each value chain process.
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is a necessary but often-complex undertaking. Diagnose the cost drivers for each value-
Historical or book values usually provide inade- creating process.
quate measures of current investment. Plant Traditional management or cost accounting
engineers, equipment vendors and independent systems often assign costs by using a single out-
appraisal professionals may be consulted to put measure of operating activity, such as output
help establish current asset values. Likewise, volume. For vertical linkage analysis, a single
establishing prices for transferring goods and measure is inadequate to capture the underlying
services among value chain processes requires cost categories. Direct labor-based measures
an understanding of market or competitive- may be appropriate for labor-intensive activities;
based rates. If at least one firm competes in operating hours may be appropriate for machine-
each stage of value creation, then competitive based activities. The cost drivers illustrated
market prices are available. If not, then a company in Exhibit 3 may be used to identify the factors
must use judgment in determining a transfer that determine costs throughout the industry
price that incorporates a normal profit margin value chain.
on full costs. For long-term strategic decision-
making, companies should use full cost under Evaluate the opportunities for sustainable
conditions of full capacity for the value activity. competitive advantage.
While several measures of capacity exist, the By nature, competitive advantage is relative. In
best measure should represent the long-term an ideal world, a firm can gauge its competitive
utilization of the value activity’s assets (some- position by knowing its competitor’s value chains
times called “practical capacity”). and the rates of return on each. In reality, howev-
er, this may be rather difficult: the competitor’s
Publicly available financial reports produced by internal cost, revenue and asset data for its
firms throughout the industry value chain can processes are generally unavailable. Sufficient
provide key financial information. Typically, this qualitative information usually exists on a firm’s
information is neither in the proper format nor major value-creating processes and the strategies
disaggregated enough to accommodate vertical for each. By understanding how other companies
linkage analysis. Significant analysis, data compete in each process of the industry value
manipulation and judgment may be necessary chain, a firm can use the qualitative analysis to
to obtain the appropriate information for each seek out competitive niches even if financial
value chain process. data are unavailable.
For intermediate transfers between processes, Value chains for three competitors in the rapidly
competitive market prices, if available, should be changing telecommunications industry—AT&T,
substituted for the internal transfer prices. For NYNEX and IBM—are listed in Exhibit 7, along with
example, competitive market prices for a single the strategic differences for each firm (Hax and
link in the value chain may be obtained from Majiuf, 1991). The strategic differences reflect vary-
individual firms that operate only in that link of ing structural and executional cost drivers. In market-
the chain. For long-term cost estimation, full ing, for instance, AT&T started with no organization
costs should be used rather than marginal, but with significant name recognition. The regional
variable or incremental costs. marketing scale of NYNEX and the worldwide mar-
keting scale of IBM are important cost advantages.
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EXHIBIT 7: VALUE CHAIN DIFFERENCES:
THE TELECOMMUNIC AT IONS INDUSTRY
EXHIBIT 7. VALUE CHAIN DIFFERENCES:
THE TELECOMMNICATIONS INDUSTRY
Strategic Differences
Value Chain
Processes AT&T NYNEX IBM
Finding innovative ways to perform value-creating and shipped the slabs to its large markets in the
Source: Hax and Majluf, 1991.
activities helps firms improve their overall perfor- Northeastern U.S. Only then did the company
mance and achieve competitive advantage. In mix the concentrate with water, thus avoiding the
order to thrive in the mature, highly competitive lengthy and costly shipment of water.
meat packing industry, for example, Iowa Beef
Processors built its plants near cattle ranches, Increased global competition forces firms to focus
thus eliminating the high cost of shipping cattle on worldwide sustainable competitive advantage.
to northern processing plants. In order to lower Porter (1990), one of a few strategists who have
its costs, Tropicana froze slabs of orange juice systematically studied global competition, cites four
concentrate near the orange groves in Florida major factors that influence national competitive
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Any price increase will then cause some customers A major difficulty in industry structure analysis
to switch to substitutes. A thorough understand- lies in defining the specific industry. No industry
ing of the value chains of buyers as they relate has clear boundaries either in terms of products
to the firm’s product can help in assessing (and or geographical areas. For example, does one
combating) the threat of substitution. analyze the industry environment of Ford as the
“transportation equipment” industry, the “motor
Threat of new entrants vehicles and equipment” industry or the
If an industry is earning a return on invested “automobile” industry?
capital above the cost of capital, that industry
will act as a magnet to firms outside the industry. To overcome the difficulty of defining an industry,
Unless the entry of new firms is barred, the rate the concept of substitutability can be applied to
of profit must fall to the competitive level. Even a firm’s supply and demand chains. On the
the mere threat of entry may be sufficient to demand side, if buyers are willing to substitute
ensure that established firms constrain their one product for another—e.g., Toyotas for Fords—
prices to the competitive level. then the manufacturers belong in a single
industry. However, this guideline does not always
Intensity of competition hold. For example, customers may be unwilling
Markets experiencing rapid growth typically see to substitute Apple Macintosh computers for
less intense competition. Rival companies can usu- Compaq computers, even though both manufac-
ally satisfy profitability and growth without having turers belong to the same industry. On the
to take market shares from their competitors. supply side, if two manufacturers can make
each other’s products, then they belong to a
The variety and nature of the value chains of single industry.
competitors shape many of the characteristics
of an industry. The relative importance of Porter’s model sometimes draws criticism for
economies of scale versus economies of scope, neglecting the difficulty of obtaining and main-
for example, depends on the kind(s) of technology taining the information required to perform an
employed in competitors’ value chains. The industry structure analysis. While such an
stability of the industry and of its competitive exercise may be time-consuming, it is essential
situation also relates to what happens to the to obtain a detailed database in order to fully
value chains of firms in the industry. The effective- understand an organization’s competitive
ness of low cost versus differentiation strategies environment. Dismissing the task as too difficult
depends on the nature of users’ value chains, is tempting, and may lead to inappropriate
and on how competitors’ value chains interact decision-making.
with those of both sellers and users.
Core Competencies Analysis
Since these five forces are ever-changing, Industry structure analysis is well suited to
Porter’s framework needs to be employed as describing the what of competitiveness, i.e., what
a dynamic analytical tool. This is because makes one firm or one industry more profitable
competition is a dynamic process: equilibrium is than another. But understanding the particulars
never reached and industry structures are of such advantages as low cost, quality, customer
constantly being reformed. service and time to market may still leave the
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PRACTICE OF MANAGEMENT ACCOUNTING
question of why largely unanswered. For example, new ways of using information technology for a wide
why do some companies seem able to continually variety of end users. In contrast, using its core com-
create new forms of competitive advantage while petence in information processing, Xerox devel-
others seem able only to observe and follow? oped icons, pull-down menus and the computer
Why are some firms net advantage creators and mouse, but failed to exploit the marketplace.
others net advantage imitators? For assessing
competitive advantage it is necessary not only to A core competence is identified by the following
keep score of existing advantages—what they tests:
are and who has them—but also to discover
what it is that drives the process of advantage ● Can it be leveraged?—does it provide potential
creation. Industry structure analysis is much better access to a wide variety of markets?
suited to the first task than to the second. ● Does it enhance customer value?—does it make
a significant contribution to the perceived
Thus, industry structure analysis must be customer benefits of the end product?
supplemented by an equally explicit core compe- ● Can it be imitated?—does it reduce the threat
tence focus. Organizations need to be viewed of imitation by competitors?
not only as a portfolio of products or services,
but also as a portfolio of core competencies. Applying the value chain approach to core com-
petencies for competitive advantage includes
Core competencies are created by superior the following steps:
integration of technological, physical and human
resources. They represent distinctive skills as ● validate core competencies in current
well as intangible, invisible, intellectual assets businesses;
and cultural capabilities. Cultural capabilities ● export or leverage core competencies to the
refer to the ability to manage change, the ability value chains of other existing businesses;
to learn and teamworking. Organizations should ● use core competencies to reconfigure the
be viewed as a bundle of a few core competen- value chains of existing businesses; and
cies, each supported by several individual skills. ● use core competencies to create new value chains.
Core competencies are the connective tissue Validate core competencies in current
that holds together a portfolio of seemingly businesses.
diverse businesses. They are the lingua franca that Core competencies should tie together the portfolio
allows managers to translate insights and expe- of end products and help a firm excel in dominat-
rience from one business setting into another. ing its industry. For example, Corning Glass’s core
Core competence-based diversification reduces competence is its ability to melt specialty glass.
risk and investment and increases the opportu- Pyrex, television bulbs, headlamps and optical
nities for transferring learning and best practice wave guides are just a few of the products of this
across business units. successful producer. Procter & Gamble’s R&D
expertise and marketing/distribution skills pro-
For instance, the New York Times stated that vide a significant competitive advantage in a wide
Microsoft’s only factory asset is the human imag- range of mass consumer products (e.g., Ivory,
ination. This company has excelled in inventing Tide, Folgers, Crisco, Pampers).
20
PRACTICE OF MANAGEMENT ACCOUNTING
EXHIBIT 8: HOW
EXHIBIT TETRA-PAK
8. HOW RECONFIGURED
TETRA-PAK THEVALUE
RECONFIGURED THE VALUCHAIN
E C HAIN
21
Source:
PRACTICE OF MANAGEMENT ACCOUNTING
air freight business by focusing on the overnight Use core competencies to create new
delivery of small packages. value chains.
With strong core competencies in its existing
Tetra-Pak is an excellent example of a firm that businesses, an organization can seek new
reconfigured the value chain in the packaging customers by developing new value chains.
industry for dairy products and orange juice.
Tetra-Pak designed a filling machine for its a For example, Federal Express (FedEx) transferred
septic packages and changed the packaging its expertise in the delivery of small packages to
industry. Exhibit 8 illustrates Tetra-Pak’s changes contract new business with L.L. Bean for
to the value chain. overnight distribution. Disney has exported its
people-moving skills to urban mass transit for
Another example of a value chain reconfiguration Oakland, California.
is IKEA, which grew from a small, Swedish mail-
order furniture operation to one of the world’s The development of the corporate purchasing
largest retailers of home furnishings (Normann & card is exporting the expertise of credit card
Ramirez, 1993). As illustrated in Exhibit 9, IKEA companies, such as American Express and Visa,
selected numerous factors to offer prices that are to process small purchase transactions for other
25-50 per cent lower than those of competitors. companies.
E X H IB I T 9 : H OW I K E A R E C O N F I G U R E D T H E F U R NI T U R E I N DU S T RY
EXHIBIT 9. HOW IKEA RECONFIGURED THE FURNITURE INDUSTRY
Source:Normann
Source: andRamirez,
Normannand Ramirez,1993.
1993.
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PRACTICE OF MANAGEMENT ACCOUNTING
If the nature and intensity of Porter’s five forces The first set of variables describes segments in
or the core competencies vary for various terms of general characteristics unrelated to the
segments of an industry, then the structural charac- product involved. Thus, a bakery might be con-
teristics of different industry segments need to be cerned with geographic segments, focusing on
examined. This analysis will reveal the competitive one or more regions or even neighborhoods. It
advantages or disadvantages of different segments. might also divide its market into organizational
A firm may use this information to decide to exit the types such as at-home customers, restaurants,
segment, to enter a segment, reconfigure one or dining operations in schools, hospitals and so
more segments, or embark on cost reduction/ on. Demographics can define segments repre-
differentiation programs. senting strategic opportunities such as single
parents, professional women and elderly people.
Differences in structure and competition among
segments may also mean differences in key The second category of segment variables
success factors among segments. includes those that are related to the product.
One of the most frequently employed is usage. A
Using the value chain approach for segmentation bakery may employ a very different strategy in
analysis, Grant (1991) recommends five steps: serving restaurants that are heavy users of
bakery products than restaurants that use fewer
● identify segmentation variables and categories; bakery products. Zenith made a niche for itself
● construct a segmentation matrix; in the very competitive personal computer
● analyze segment attractiveness; industry by focusing on government, which is
● identify key success factors for each segment; the largest computer user.
and
● analyze attractiveness of broad versus narrow Segmenting by competitor is useful because it
segment scope. frequently leads to a well-defined strategy and a
23
PRACTICE OF MANAGEMENT ACCOUNTING
Customer Characteristics
Product-related Approaches
24
PRACTICE OF MANAGEMENT ACCOUNTING
E X H IB I T 1 1 : S E G M E N T I N G TH E B RI T I S H F RO Z E N F O O D I N D US T RY
EXHIBIT 11. SEGMENTING THE BRITISH FROZEN FOOD INDUSTRY
DISTRIBUTION CHANNELS
Supermarkets
Independent Specialist
Producers’ Retailers’ Grocery Freezer
Brands Brands Retailers Stores Caterers
Vegetables
P
R
O Fruits
D
U
C Meat
T Products
T
Y Desserts
P
E
S Convenience
Ready Meals
Note: The above matrix identifies five categories of frozen food, and five distribution channels. While the basic
distinction of customers is between retail and catering, within retailing there are three distinct categories of outlet:
supermarkets, independent grocery stores, and specialist retailers of frozen food (”home freezer centres”). In
addition, different market conditions exist for processors supplying frozen foods for sale under their own brand
names as opposed to those supplying frozen foods for sale under the brand name of the retailer.
Source: Monopolies and Mergers Commission, Frozen Foods (HMSO, London 1976); and P. Geroski and T. Vlassopoulos,
“The rise and fall of a market leader; Frozen foods in the UK,” London Business School, Case series 9, 1989.
Source: Monopolies and Mergers Commission, Frozen Foods (HMSO, London 1976); and
P. Geroski and T. Vlassopoulos, “The rise and fall of a market leader; Frozen foods in the UK,”
A segmentation matrix for London the British
Businessfrozen
School, Casebeseries
used9,to evaluate the profitability of different
1989.
foods industry is presented in Exhibit 11. Five segments. However, the competitive focus shifts
types of product and five channels of distribution to an analysis of the different segments.
are used to construct the two-dimensional seg-
mentation matrix consisting of 25 potential For example, in the frozen foods industry seg-
segments. However, not every cell in the matrix mentation, independent grocers and caterers
may be relevant. Empty cells may represent may be willing to substitute fresh fruits and
future opportunities for products or services. vegetables for frozen goods. Therefore, the
threat of substitutes within the segments and
Analyze segment attractiveness. from outside sources must be carefully examined.
Competitive assessments using industry structure
analysis or core competencies analysis can also
25
PRACTICE OF MANAGEMENT ACCOUNTING
In addition, the interrelationship among segments On the other hand, when the Toro Company
must be carefully considered. For example, caterers broadened its distribution channels for its snow
may purchase frozen food items from supermar- blowers and lawnmowers to include discount
kets at bargain prices. Segments may be natural chains, it almost went bankrupt. Feeling
buyers, sellers or substitutes for one another. betrayed, a number of Toro’s dealers dropped
its products.
In the automobile industry, the luxury car and
sports car segments were high-priced, high-margin Taking a narrow segment focus may leave a firm
products with less intense competition than vulnerable to competitors. For instance, by relying
other automobile segments. The introduction of solely on its lemon-lime soft drink, 7-Up left itself
high-quality, lower-priced Acura, Lexus and Infiniti at a competitive disadvantage to Coca-Cola and
autos changed the competitive structure of Pepsi. Recently, Hallmark Cards Co. has begun
these high-priced segments. to market its premium image greeting cards
through discounters. Hurt by discounters, some
Identify key success factors for each of Hallmark’s 9,000 independent specialty
segment. shops have begun selling cards from Hallmark’s
Quality, delivery, customer satisfaction, market competitors.
share, profitability and return on investment are
common measures of corporate success. In this In many industries, aggressive firms are moving
regard, each segment must be assessed using toward multiple-segment strategies. Campbell
the most appropriate key success factors. Cost Soup, for example, makes its nacho cheese
and differentiation advantages should be high- soup spicier for Texas and California customers
lighted by these measures. and offers a Creole soup for Southern markets
and a red-bean soup for Hispanic areas. In New
Examination of differences among segments in York, Campbell uses promotions linking
buyers’ purchase criteria can reveal clear differ- Swanson frozen dinners with the New York
ences in key success factors. Giants football team; in the Sierra mountains,
skiers are treated to hot soup samples.
Analyze attractiveness of broad versus Developing multiple strategies is costly and
narrow segment scope. often must be justified by an enhanced
A wide choice of segments for an industry aggregate impact.
requires careful matching of a firm’s resources
with the market. The competitive advantage of Some firms decide to avoid or abandon segments
each segment may be identified in terms of low because of limited resources or because of uncer-
cost and/or differentiation. tain attractiveness. For example, in the 1960s,
IBM decided not to enter the mini-computer
Sharing costs across different market segments segment. This allowed upstart Digital Equipment
may provide a competitive advantage. For example, Corp. to dominate this segment of the computer
Gillette broadened its shaving systems to industry. General Electric abandoned the computer
include electric shavers through its 1970 acqui- industry completely. Under CEO Jack Welch, GE’s
sition of Braun. Lipton recently entered the major segments must be first or second in market
bottled iced-tea market. share, or risk being sold.
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PRACTICE OF MANAGEMENT ACCOUNTING
A segment justifying a unique strategy must be or services with no external or competitive market
of worthwhile size to support a business strategy. information, transfer prices must be estimated
Furthermore, that business strategy needs to be on the basis of the best information available.
effective with respect to the target segment in
order to be cost effective. In general, it is costly Isolating cost drivers for each value-creating
to develop a strategy for a segment. The question activity, identifying value chain linkages across
usually is whether or not the effectiveness of the activities, and computing supplier and customer
strategy will compensate for this added cost. profit margins present serious challenges. The
use of full cost assumes that the full capacity of
V I I I . L I M I TAT I O N S O F VA L U E the value chain activity’s facilities is used to
C H A I N A N A LY S I S derive the costs. Plant and manufacturing
Value chain analysis is neither an exact science personnel and vendors of equipment are good
nor is it easy. It is more art than preparing sources for capacity information. They can also be
precise accounting reports. There are several helpful in estimating the current or replacement
limitations to the implementation and interpreta- cost of the assets. Independent companies,
tion of value chain analysis. First, the internal such as Valuation Research Corp. in Milwaukee,
data on costs, revenues and assets used for provide valuation services for assets.
value chain analysis are derived from one period’s
financial information. For long-term strategic Despite the calculational difficulties, experience
decision-making, changes in cost structures, indicates that performing value chain analysis
market prices and capital investments from one can yield firms invaluable information on their
period to the next may alter the implications of competitive situation, cost structure, and link-
value chain analysis. Organizations should ages with suppliers and customers.
ensure that the value chain analysis is valid for
future periods. Otherwise, the value chain analy- I X . O R G A N I Z AT I O N A L A N D
sis must be repeated under new conditions. MANAGERIAL ACCOUNTING
CHALLENGES
Identifying stages in an industry’s value chain is Value chain analysis offers an excellent opportunity
limited by the ability to locate at least one firm to integrate strategic planning with management
that participates in a specific stage. Breaking a accounting to guide the firm to growth and survival.
value stage into two or more stages when an This change in focus for management accounting
outside firm does not compete in these stages is necessary to maintain its critical role as the
is strictly judgmental. information profession.
As discussed previously, finding the costs, The most significant challenge for senior man-
revenues and assets for each value chain activity agement and management accountants is to
sometimes presents serious difficulties. There is recognize that the traditional, functional, internally
much experimentation underway that may provide oriented information system is inadequate for
better approaches. Having at least one firm operate the firm engaged in global competition.
in each value chain activity helps identify external
prices for goods and services transferred Another challenge for management accountants
between value chains. For intermediate products is to bring the importance of customer value to
27
PRACTICE OF MANAGEMENT ACCOUNTING
the forefront of managements’ strategic thinking. management accountant should ensure that the
For many managers and firms, this requires a CEO is committed to value chain analysis and
great deal of education and awareness. the organizational changes necessary for its
Management accountants should take the initia- successful implementation.
tive to bring the value chain message to major
players in the firm. Seminars, articles, value For many service companies, Porter’s value chain
chain examples and company-specific applica- model emphasizing manufacturing firms may
tions are useful to illustrate the advantages of appear inappropriate. However, every organization
value chain analysis. (banks, hospitals, airlines, professional firms)
has a variety of primary and support value-creating
Although value chain analysis requires expertise activities to which value chain analysis applies.
in internal operations and information, it For example, a publishing company might have
demands a great deal of external information. the following primary activities: information
Management accountants must seek relevant acquisition, editorial, production, distribution,
financial and non-financial information from sales and service. Support activities include new
sources outside the organization. product and business development, technology
assessment and development, human resource
Management accountants must integrate data- management and firm infrastructure. If strategy
bases and potential sources of timely information is seen as the pursuit of competitive advantage,
on competitive forces confronting the business. the link between the formulation of service
This calls for innovation and creativity in strategy and operational service delivery is vital.
gathering and analyzing information for manage-
ment decisions. X. CONCLUSION
As a unifying theme, value chain analysis presents
Designing internal and external information sys- organizations with an overarching tool for improving
tems to assist managers in planning, monitoring their strategic planning and resource allocation.
and improving value-creating processes is another The goal is to provide management with sufficient
challenge facing management accountants. options to sustain its competitive advantage in an
ever-changing business environment.
Information technology is improving daily but
existing information systems are slow to change. Analyzing costs and differentiation through the
Management accountants should solicit support value chain is an essential component in the search
from all senior managers for allocating for competitive advantage. The data problems
resources to develop and improve value chain- are not insignificant and the answers will not
oriented information systems. always be precise.
Value chain analysis requires the cooperation of Nevertheless, there will be considerable benefit
all managers involved in value chain processes, in the debate that results from the process and
including engineers, designers, production in the enhanced quantitative awareness of the
managers, marketing managers and distribution external competitive arena and of the firm’s part
managers. Leadership from the CEO is vital to in it. As so often in strategic planning, the
successful cooperation of managers. The process is often as valuable as the outcome.
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PRACTICE OF MANAGEMENT ACCOUNTING
A P P E N D I X : VA L U E C H A I N
A N A LY S I S V S . C O N V E N T I O N A L
MANAGEMENT ACCOUNTING
Information generated from the traditional man-
agement accounting systems, including cost
accounting, is generally unsuitable for value
chain analysis for a variety of reasons. Exhibit A-1
provides a comparison of value chain analysis
and traditional management accounting.
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PRACTICE OF MANAGEMENT ACCOUNTING
E X H I B I T A - 1: VA L U E C H A I N V S . C ON V E N T I O NA L
EXHIBIT A-1. VALUE CHAIN M AVS.
N AG E ME N T AC C OMANAGEMENT
CONVENTIONAL UNTING ACCOUNTING
30
PRACTICE OF MANAGEMENT ACCOUNTING
31