Strategic Business Leader (SBL)

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Strategic Business Leader (SBL)
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Sales revenue X
Variable/relevant production costs (X)
Gross contribution X
Relevant marketing and selling costs (X)
Contribution X
To analyse customer profitability, information is needed about the relevant costs of

selling to each particular type of customer. This information might be obtained from
activity based costing, where activities associated with different categories of
customer can be identified and costed. Examples of cost drivers might include the
following:
 Order size - for example, some types of customer might buy in large volume
orders, whereas another type of customer might buy in small size orders.
 Order processing - the annual costs of processing and delivery per unit sold will
probably be much lower for the customers who make large orders. These
customers could therefore be much more profitable.
 Management time
 Level of after-sales service
 Cash flow and credit costs e.g. the higher cost of selling to late rather than
prompt paying customers.
Improving customer profitability

An examination question may require you to suggest how profitability can be
improved. Strategies for improving customer profitability might involve the
following:
Improved processes. Improvements could be made in the processes used to
supply customers, such as reducing production costs or distribution costs
through initiatives such as ‘just-in-time’ and lean manufacturing.
Pricing. Large customers may be unprofitable if they are given large price
discounts.
Managing customer relationships. Companies spend money to develop
customer relationships. For example, they may spend heavily on advertising to
win new customers, or they may employ sales representatives to develop
relationships with key clients. Customer profitability can be improved by making
sure that the benefits from additional sales are more than the costs incurred in
developing and maintaining the relationships. For example, it is not worth
spending money on advertising for new customers, if the profits they provide are
less than the cost of the advertising.
Another very useful technique is Porter’s value chain analysis. This is discussed in
the next sections.
322 © Emile Woolf International Limited
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Chapter 11: Internal resources, capabilities and competences
Value chain
 Definition of value
 The concept of the value chain
 Primary value chain
 Secondary value chain activities: support activities
 Adding value
 Value creation and strategic management
 Using value chain analysis
5 Value chain
5.1 Definition of value

Value relates to the benefit that a customer obtains from a product or service. Value
is provided by the attributes of the product or service. Customers are willing to pay
money to obtain goods or services because of the benefits they receive. The price
they are willing to pay puts a value on those benefits.
Business entities create added value when they make goods and provide services.
For example, if a business entity buys a quantity of leather for $1,000 and converts
this into leather belts, which it sells for $10,000, it has created value of $9,000.
In a competitive market, the most successful business entities are those that are most
successful in creating value. Porter has suggested that:
 if a firm pursues a cost leadership strategy, its aim is to create the same value as
its competitors, but at a lower cost
 if a firm pursues a differentiation strategy, it aims to create more value than its
competitors.
The only reason why a customer should be willing to pay a higher price than the
lowest price in the market is that he sees additional value in the higher-priced
product, and is willing to pay more to obtain the value.
 This extra value might be real or perceived. For example a customer might be
willing to pay more for a product with a well-known brand name, assuming that
a similar non-branded product is lower in quality. This difference in quality
might be imagined rather than real; even so, the customer will pay the extra
amount to get the branded product.
 The extra value might relate to the quality or design features of the product.
However, other factors in the marketing mix might persuade a customer that a
product offers more value. For example, a customer might pay more to buy one
product than a lower-priced alternative because it is available immediately
(convenience) or because the customer has been attracted to the product by
advertising.
© Emile Woolf International Limited 323

5.2 The concept of the value chain

A framework for analysing how value can be added to a product or service has been
provided by Porter.
Porter (‘Competitive Strategy’) grouped the activities of a business entity into a

value chain. A value chain is a series of activities, each of which adds value. The
total value added by the entity is the sum of the value created by each stage along
the chain. This total value added is referred to as margin and represents the excess
that the customer is prepared to pay above the underlying cost to the company of
obtaining resources and providing value activities.
Johnson and Scholes have defined the value chain as: ‘the activities within and
around an organisation which together create a product or service.’
Strategic success depends on the way that an entity as a whole performs, but
competitive advantage, which is a key to strategic success, comes from each of the
individual and specific activities that make up the value chain.
Within an entity:
 there is a primary value chain comprising ‘primary activities’, and
 there are support activities (also called secondary value chain activities).
Linkages describe the relationships between activities.
5.3 Primary value chain

Porter identified the chain of activities in the primary value chain as follows:
This value chain applies to manufacturing and retailing companies, but can be
adapted for companies that sell services rather than products.
Most value is usually created in the primary value chain.

 Inbound logistics. These are the activities concerned with receiving and
handling purchased materials and components, and storing them until needed.
In a manufacturing company, inbound logistics therefore include activities such
as materials handling, transport from suppliers and inventory management and
inventory control.
 Operations. These are the activities concerned with converting the purchased
materials into an item that customers will buy. In a manufacturing company,
operations might include machining, assembly, packing, testing and equipment
maintenance.
 Outbound logistics. These are activities concerned with the storage of finished
goods before sale, and the distribution and delivery of goods (or services) to the

customers. For services, outbound logistics relate to the delivery of a service at

the customer’s own premises.
 Marketing and sales. These are the activities that inform customers about the
product or service and persuade them to make a purchase. Includes activities
such as advertising and promotion.
 Service. These are all the activities that occur after the point of sale, such as
installation, warranties, repairs and maintenance, providing training to the
employees of customers and after-sales service.
The nature of the activities in the value chain varies from one industry to another,
and there are also differences between the value chain of manufacturers, retailers
and other service industries. However, the concept of the primary value chain is
valid for all types of business entity.
5.4 Secondary value chain activities: support activities

In addition to the primary value chain activities, there are also secondary activities
or support activities. Porter identified these as:
 Procurement. These are activities concerned with buying the resources for the
entity – materials, plant, equipment and other assets.
 Technology development. These are activities related to any development in the
technological systems of the entity, such as product design (research and
development) and IT systems. Technology development is an important activity
for innovation. ‘Technology’ also includes acquired knowledge: in this sense all
activities have some technology content, even if this is just acquired knowledge.
 Human resources management. These are the activities concerned with
recruiting, training, developing and rewarding people in the organisation.
 Corporate infrastructure. This relates to the organisation structure and its
management systems, including planning and finance management, quality
management and information systems management.
Support activities are often seen as necessary ‘overheads’ to support the primary
value chain, but value can also be created by support activities. For example:
 Procurement can add value by identifying a cheaper source of materials or
equipment
 Technology development can add value to operations with the introduction of a
new IT system
 Human resources management can add value by improving the skills of
employees through training.
 Corporate infrastructure can help to create value by providing a better
management information system that helps management to make better
decisions.

5.5 Adding value

Strategic management should look for ways of adding value because this improves
competitiveness (creates competitive advantage).
 Management should look for ways of adding more value at each stage in the
primary value chain.
 Similarly, management should consider ways in which support activities can
add more value.
Finding ways of adding value is a key aspect of strategic management. Answers
need to be provided to a few basic questions:
 Who is the customer?
 What features of the product or service do they value?
 How do we provide value to the customer in the products or services we
provide?
 How can we add to the value that the customer receives?
 How can we add value more successfully than our competitors? Do we have
some core competencies that we can use to give us a competitive advantage?
Methods of adding value

There are different ways of adding value.
 One way of adding value is to alter a product design, and include features that
might meet the needs of a particular type of customer better than products that
are currently in the market.
A product might be designed with added features.
Market segmentation is successful when a group of customers value particular
product characteristics, and are willing to pay more for a product that provides
them.
 Value can be added by making it easier for the customer to buy a product, for
example by providing a website where customers can make purchases.
Bookstores can add value to the books they sell by providing sales outlets at
places where customers often want to buy books, such as airport terminals.
 Value can be added by promoting a brand name. Successful branding might give
customers a sense of buying products or services with a better quality.
 Value can be added by delivering a service or product more quickly. For
example, a private hospital might add value by offering treatment to patients
more quickly than other hospitals in the region.
 Value can also come from providing a reliable service, so that customers know
that they will receive the service on time, at the promised time, to a good
standard of performance.
New product design (innovation) is also concerned with creating a product that
provides an appropriate amount of value to customers.

When a business entity is planning to expand its operations into new markets or
new market segments, it should choose markets for expansion where the
opportunities for adding value are strong.
It is also important to recognise that value is added by all the activities on the
primary value chain, including logistics. Customers might be willing to pay more
for a product or a service if it is delivered to them in a more convenient way. For
example, customers might be willing to pay more for household shopping items if
the items are delivered to their home, so that they do not have to go out to a
supermarket or a store to get them.
Core competencies and the value chain

There is an important link between value and CSFs for products and services. CSFs
underpin the elements of the product or service that provide value for the customer
and should therefore be the primary focus of the organisation.
Activities from which the organisation does not derive significant value could
feasibly be outsourced.
5.6 Value creation and strategic management

By adding value more successfully, a firm will improve its profitability, by reducing
costs or improving sales. Some of the extra benefit might be passed on to the
customer, in the form of a better-quality product or service or a lower selling price.
If so, the business entity shares the benefits of added value with the customers, and
gains additional competitive advantage.
Added value does not have to be given immediately to customers (in the form of
lower prices) or shareholders (in the form of higher dividends). The benefits can be
re-invested to create more competitive advantage in the future.
There is a link between:

 corporate strategy, which should aim to add value for the customer
 financial strategy, which should aim to add value for the shareholders and
 investment strategy, which should aim to ensure that the entity will continue to
add more value in the future.

5.7 Using value chain analysis

The value chain model is another useful model for business strategy analysis. It can
be argued that in business, the most important objective for success should be to
add value better than competitors. Creating value for customers will, over the long
term, create more value for shareholders.
Since adding value is critical to the success of a business entity, it should be

important to identify how it creates value, where it is creating value and whether it
could do better (and create more value). The entity’s success in creating value can be
compared with the performance of competitors. Who is doing better to create value
for customers?
In your examination, the value chain model can be used to make a strategic
assessment of performance. Each part of the primary value chain and each of the
secondary value chain activities should be analysed. For each part of the value
chain, providing answers to the following questions can assess performance:
 How is value added by this part of the value chain?
 Has the entity been successful in adding value in this part of the value chain?
 Has the entity been more successful than its competitors in adding value in this
part of the value chain?
 Has there been a failure to add value successfully?
 Does the entity have the core competencies in this part of the value chain to add
value successfully? (If not, a decision might be taken to out-source the activities.)

Value network
 Difference between a value chain and a value network

 Elements in a value network
 The strategic significance of value networks
6 Value network
6.1 Difference between a value chain and a value network

There is a value chain within every business entity.
There is also a supply chain from the producers of raw materials and equipment
through to the entities that sell the end consumer product to customers.
For example, food products might go from the original food producer to a food
processor (who makes the processed food item) to a retailer. Here, there are three
firms in the supply chain from the original food source to the end consumer. Each
firm in the supply chain has its own value chain.
A value network, also called a value system, is the sum of the value chains in all the
firms in a supply chain.
The value that the end-consumers customers pay for when they buy goods or
services comes from the value created by the entire value network.
Definition
A value network can be defined as ‘any web of relationships that generates tangible
and intangible value through complex, dynamic exchanges between two or more
individuals, groups or organisations’.
Through networks, a company with a small number of employees can actually have
a value network with a large number of different suppliers and customers.
6.2 Elements in a value network

For many business entities, the value network is more complex than a chain of
suppliers, from raw materials to end product. Other entities are also included in the
value network. These can be categorised as:
 Intermediaries. These are entities that provide outsourced services (such as out-
sourced book-keeping or outsourced logistics management) and support
services (such as public relations advisers).
 Complementors. These are entities that provide additional and complementary
products or services.

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