Industry Value Chain Analysis – Michael Porter’s Value System

by Paul Simister on September 25, 2011

Using the concept of the industry value chain analysis is an important part of gaining an appreciation for the wider competitive factors that can impact on your business.

Background To The Industry Value Chain Or Value System

The idea of the value chain was introduced in the classic strategy book Competitive Advantage by Michael Porter as a way to understand and develop competitive advantage.

While much of the book looks at the value chain within a business, Michael Porter stresses the importance of linkages between the business and its suppliers and customers which gives rise to the analysis of the industry value chain or what Michael Porter called the Value System.

For more details of the value chain within a business please see:

Using the Value Chain For Competitive Advantage

The Advantages & Disadvantages Of The Value Chain

Videos About The Value Chain

What is Industry Value Chain Analysis

A business takes some form of input and creates an output product or service that a customer is willing to pay for.

Most businesses therefore buy products from suppliers and sell to customers who then either sell the product as it is or use it to create another product or service to sell.

This creates a value chain (or a value system) of suppliers and customers in an industry.

For example, a cheese company buys milk from farmers, turns it into cheese and sells it to a distributor who then sells it to the supermarkets who sell it to the consumer. That’s an industry value chain as each step in the process creates an element of value that the customer is willing to pay for in the final price.

Value chains can also branch out into different distribution channels so staying with the cheese company example,as well as the supermarket route to the consumer, the distributor also sells to food processing companies who use the cheese to create ready-made meals to sell to the supermarkets.

The supermarkets sell to local restaurants who use the cheese in their menus and the local sandwich businesses that provide your lunch.

Each activity within the industry value chain has its own needs and preferences and plays some role in shaping the product and the value the ultimate consumers gets from the product. Each activity has its own cost dynamics and the way the activities link together can either add value or create unnecessary costs.

Industry value chain analysis allows you to look at the way the entire system works together to help you to find ways to create competitive advantage so your business earns higher profits.

The Industry Value Chain Analysis System

The diagram below shows five different activities within the industry value chain or value system.

Industry Value Chain Analysis The Industry Value Chain shows the alternative ways of competing, each with advantages and disadvantages

I’d like you to imagine that you are the business highlighted in yellow, a provider of the third activity in the value chain which links various independent suppliers.

You analyse the industry value chain and whilst there are many independents like you, you notice that there are some competitors that are set up differently.

  • One competitor who is vertically integrated backwards i.e. they have a business that combines what you do with your immediate supplier. This gives them an advantage over control of the incoming supplies and means that supply priorities can be much clearer, However there is a balancing act for scale efficiencies since the two processes are linked.
    .
  • Another competitor is part of a group which has three business units, the first deals with the first two stages of production, the second does what you do and the next stage and the third sells the product to the final consumer.
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  • The final competitor in the industry value chain is a fully integrated business that does all five steps.

Industry Value Chain Analysis – A Look At What Is

Once you’ve sketched out the industry value chain or value system, you’ll have a broader view of how you fit into the market since you’ll see yourself as part of a value delivery system which competes with alternative value delivery systems.

You can start looking at the implications of each.

  • What causes cost and value to accumulate within an activity?
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  • How some value chains create advantage for those who use them and how you can respond or react?
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  • How profit accumulates in particular sections of the industry value chain? The classic example is the portable computer industry where Intel and Microsoft have created strong strategic positions which capture a high proportion of the overall profits made in the industry value chain, leaving other component manufacturers, PC assemblers and PC distributors trailing.

Understanding what is currently happening in your industry can help you to look at

  • Business definition issues – what activities in the industry value chain should you be doing? Should you vertically integrate backwards or forwards? Or should you focus on building up your core competences in a tightly defined area and establish a strategic control position, just like Intel and Microsoft?
    .
  • How you can create competitive advantage and where it is futile to try because the business design of your competitors has major strengths and weaknesses?
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  • Where your own business model is vulnerable to competitive attack and what you can do about it?

Industry Value Chain Analysis – A Look At What Might Be

The book Profit Patterns by Adrian Slywotzky and David Morrison makes it clear that industry value chains used to be stable over the long term but over the last twenty years there has been much more movement which creates profound impact on the businesses operating within them.

Unfortunately many businesses miss the changes that are happening around them until it is too late and they are trapped in a no profit zone and business system. This is a significant threat which should be identified and included in your SWOT Analysis.

They identify a number of value chain related profit patterns to look out for:

  • Value Chain Convergence – competitors from previously distinct industries start to compete against each other as their products compete to meet the consumers’ underlying needs. As an example, think about how Skype and the other voice over the Internet providers have damaged traditional telephone service providers like British Telecom. Or how the development of smart phones impact on lap top PC providers and how touchpad products like the iPad make the dividing line between products much fuzzier. Slywotzky and Morrison identify three levels of convergence – supplier convergence, product convergence and complementor convergence.
    .
  • Value Chain Deintegration – businesses focused on one value activity have created strategic control positions that capture a high share of the profits created by the entire value chain – this is the Microsoft or Intel example.
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  • Value Chain Squeeze – how growing strength of operators in the activities either side of a particular value in the industry chain can apply the buyer power and supplier power from Porter’s Five Forces to create a no profit zone.
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  • Value Chain Strengthening The Weak Link – one activity in the industry value chain may be systematically destroying value for the entire chain through high costs and poor quality and service. Strengthening this weak link can put a business in a very powerful position to exert influence and capture profit from the entire chain.
    .
  • Value Chain Reintegration – while disintegration can create value, so can reintegration. Apple was once a struggling business that was losing the PC operating system against Microsoft because of its refusal to let others use its operating system. Now look at it and the control it has over many stages in the industry value system, outsourcing when appropriate but keeping control over key elements including close links with consumers through the Apple stores.

Changes to the industry value chain are a little like the analogy of the boiled frog who doesn’t notice that the water is gradually getting hotter until it is too late, by which time it’s too sleepy to do anything.

The way to look out for industry value chain movements and what might be happening is through competitive analysis to keep track of changes each year. This way you can get an early warning of the patterns that might be developing in your industry and have the time to either decide to participate or to create defensive strategies.

Industry Value Chain Analysis – A Look At What Could Be

The third element of industry value chain analysis is to use it pro-actively to think about how you can configure it to your advantage over the long term.

You don’t have to wait for the profit patterns to happen based on the actions of competitors, if you see the opportunity you can start the process yourself.

Opportunities arise from:

  • Deregulation of previously regulated activities
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  • Changing customer needs and priorities
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  • Technology changes

Your competitors, who may not use industry value chain analysis, might not notice what you are doing or might not realise the significance of your actions until you’ve established a long-lasting advantage.

Industry Value Chain Videos

I found these value chain videos from Professor Andrew Fearne which focus on the industry value chain or value system.

Have You Used Industry Value Chain Analysis?

Have you used industry value chain analysis and found it helpful to:

  • Understand what is happening in your wider competitive space?
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  • Identified potential threats early?
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  • Identified opportunities?

Please leave a comment and share your experience or any tips you’ve found that makes doing the industry value chain analysis easier.
Paul Simister is a business strategy coach who helps business owners to differentiate their businesses and develop winning strategies. Get your free copy of the ebook The Six Steps Profit Formula.

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