Looking at the links in a value chain

A business constructs its value chain from the sequence of activities that it engages in to increase the value of its products and services in the eyes of its customers (see Figure 10-1). The chain shows where a business may have an advantage over its competitors, and it connects a company to the marketplace, making sure that it doesn’t stray too far from the customers it plans to serve. The links in a value chain help you better understand your business activities.

Primary links in the value chain are the business functions representing the heart of what your company does (see Chapter 9). Primary links are usually sequential. They’re the essential stages that your company goes through in developing, producing, and getting products to market, and they often involve the following:

• Research and development
• Operations
• Marketing and sales
• Distribution and delivery
• Post-sale service

Supporting links in the value chain contribute to the overall success of the business by strengthening your company’s primary links. Supporting links are often spread throughout an organization. They assist and tie together all the primary business functions, as well as support one another. The activities often involve the following:

• Management, involving support functions such as human resources (HR), legal, and information technology (IT)
• Ecosystem partners who share resources or expertise with you
• Organizational structure
• Strategic planning skills
• Financial and accounting control

We note previously that strategic management is about resource allocation: No organization has unlimited resources, so it’s absolutely fundamental that you provide those activities that are most responsible for your success with what they need. At the same time, you want to ensure that you’re not overfunding activities that are perhaps necessary but not as critical. A value chain analysis allows you to figure out which of these links is most critical to success. The concept is actually quite old, although it wasn’t recognized as such for some time. See the example of U.S. Steel in the nearby sidebar.

Forging your value chain

To develop your company’s value chain — the sequence of activities that you go through in the process of adding value to your products and services — you need a list of your company’s capabilities and resources. Take a look at Chapter 9 if you need help.

You can construct a framework for your value chain by creating a grid that divides your business into value-creating areas (see Figure 10-2). You place activities in the grid based on whether they act as part of your primary business functions, or whether you associate them with supporting areas.

Follow these steps to create the grid that shapes your value chain:

1. List all the key business areas that work to put together your company’s products and services and get them out to customers.

   Include such departments as R&D, operations, marketing, sales, distribution, delivery, and service. (See Chapter 9 for more details on these areas.)

2. Arrange a list of key business areas in order, from the first good idea R&D produces to the finished product or service.

3. List the general business areas in your company that support the primary business functions.

   Include such supporting areas as management, IT, organization and human resources, strategy and planning, ecosystem partners, and financial and accounting control.

4. Construct a grid similar to the one you see in Figure 10-2, using your lists of primary and supporting business areas.

Your value chain may not look exactly like all those organization charts you see floating around your company. Figures 10-1 and 10-2 are generic in nature; not every link necessarily applies to your own organization. The primary and supporting business functions that add customer value may be framed differently, depending on whom you ask, so you should talk to customers and to co-workers. Ask your customers to describe your business as they see it — like consultants, they may have a better vantage point. You may end up with a value chain that is either longer or shorter, depending on your business’s own unique characteristics.

To fill in the value-chain grid, you have to fill in all the specific value-adding activities — the capabilities and resources that your company uses to increase the value of your products and services. Follow these steps:

1. Go through the lists of capabilities and resources that you identify in Chapter 9 and make a first pass at placing them in the value-chain grid.

2. In the boxes on the left side of the value-chain grid, place value-adding activities that directly contribute to your primary business functions.

   These activities make up the primary links in your value chain.

3. Place value-adding activities that you associate with supporting functions in grid boxes across from the primary functions that they support.

   These activities make up the supporting links in the value chain.

4. On the grid, include a description of the customer value that the various links add, as well as how they add that value.

The value chain offers you a unique look at your company through your customers’ eyes. Every link in the value chain is something that you do as a company. Every link is an activity that you spend money on. It helps if you have a good cost-accounting system in place. Cost accounting is the method by which you track costs to specific activities. In general, you should be spending the most on those activities that create the greatest value for your customers; activities that are not as valuable should accordingly be less costly. If you discover through research that some activity you’re undertaking is not as valuable as you thought in the eyes of the customer, then it’s a pretty strong signal to re-allocate those resources to where they are more important — or even to outsource or totally eliminate that activity if possible. The value chain allows you to see exactly what value customers get out of each link. It gives you a relatively clear picture of why you stay in business, as well as where you could do a better job.

Understanding your value proposition

One of the leading American gaming institutions (OK, casinos) had a problem. It had located about ten of its restaurants in a semicircle between two huge gambling halls where the slot machines and other games of chance were located. But a number of those restaurants were doing very poorly, with few diners. No matter how many changes were made — food choice, format, design — nothing was working. And then something else was realized: The poorly patronized ones were on the left side of the restaurant pavilion.

Guess what? Approximately 90 percent of people are right-handed (this is called lateral dominance). Due to some neurological tic, we tend to favor the dominant side of our body. Only a few hungry patrons started off on the left side of the pavilion and couldn’t wait to get back to the slots. The advantage of the well-patronized restaurants there? Location, location, location!

You can find your own competitive advantage by listening to (and sometimes looking at) your customers and how they behave. Then use the value chain (see the previous section) to boil it all down into a clear statement of what benefits you provide your customers and what real value they place on them. Businesspeople refer to the previous statement as the value proposition — fancy jargon for a simple idea. A value proposition may be similar to your company’s mission statement (see Chapter 4 for the details), but the proposition is more narrowly focused on customers — what you provide them and what they take away. Consider this: When a potential customer is searching the web for a particular good or service and they come across your site, it has been estimated that they will spend no more than 15 seconds before moving on if they aren’t engaged. This means you have to have a clear concept of what you offer and why it’s valuable and be able to communicate it efficiently and effectively.

Consider these examples:

• Shopify lets you know it can handle all your e-commerce needs, from selling to shipping to processing payments, no matter where you sell from.
• Rolex offers unparalleled luxury and the ultimate in snob appeal in the world of timepieces.
• Slack makes users’ working lives simpler, more pleasant, and more productive.

But companies often provide their customers with more value than first meets the eye — even more value than the businesses themselves may realize.

How will you make money?

Whether you like it or not, at some point you have to get down to the nuts-and-bolts details of your company’s finances — income statements, balance sheets, cash flow, budgeting, and all that numbers stuff. We try to make it as painless as possible in Chapters 11 and 12. For now, you need to ponder something much more basic: generating profit. A business plan describes how you’re going to compete — what you will do, your customers and value proposition, how you position yourself against the competition, and the like. But a business model should describe how to make money out of your plan. Do you know how you’re going to accomplish this?

Simple, you say. Your customers give you money in exchange for the products and services you provide, right? A simple exchange. Well, much like the value chains that support them (refer to the earlier section “Describing What You Do Best”), business models aren’t always that obvious or straightforward. Do you really think that Google is just a search engine and Facebook a social media platform? In fact they are both advertising agencies — to the extent that well over 90 percent of their considerable profit comes from selling ads. Businesses often make a profit on areas outside of the main product or service that customers don’t focus on. These areas can bring great success. Some surprising examples of this follow:

• Given the price of a good meal out, you may think that successful restaurants rake in the dough. And many of them do. But fine dining restaurants make the bulk of their profits not on those delicious appetizers and entrees, but on the drinks that they serve before, during, and after the meal. For many of these restaurants, wine is the single biggest source of profit.
• Do you recall Blockbuster Video, the DVD rental chain that flourished in the pre-streaming days? At one time it had more than 9,000 stores. One reason it ultimately failed was because the video rental business had a little secret: Blockbuster made nearly $1 billion in late fees, some 70 percent of its profit. When Netflix got started as a mail-order DVD rental outfit, it eliminated those irksome charges, and customers loved the resulting savings. Blockbuster went bust soon after.

So, have you figured out yet how you can profit from your own business?

How’s your timing?

How you expect to make your money is only one part of your business model. An equally important piece relates to when you get the cash. It may seem nice to think that the green is going to start pouring in tomorrow; however, reality suggests that your company may begin incurring costs and spending money months (or maybe even years) before a revenue stream begins to flow. In the case of pharmaceuticals, for instance, a company can spend years and tens if not hundreds of millions of dollars developing and testing a drug before the first physician prescribes it and a health-care plan pays out a reimbursement.

If your business must spend money before it starts sending out those invoices, your business model must include a timeline that takes the following factors into account:

• The up-front costs you expect when you set up your business (refer to Chapter 12 for more information on how to make a budget)
• The source of funds to pay for your up-front costs (see Chapter 2 for good ideas on how to fund a new business venture)
• A schedule showing when you expect cash to roll in (check out the section on projected cash flow in Chapter 12)

The question of timing is as important for small companies as it is for big ones. The number one reason for small business failure is lack of sufficient cash flow, or access to capital. Many retail businesses that operate year-round actually take in most of their revenue during only one season — summer for family holiday venues or the Christmas holiday rush. In some cases, retailers rake in half of their annual revenues during late November and December. Timing for these establishments is quite literally a make-or-break affair.

Searching for a competitive advantage

What makes particular establishments, like Powell’s Books in Portland, Oregon, so unique? Or for that matter, Amazon? (See the nearby sidebar “David meets Goliath” for more about these two businesses.) Every business that’s been successful over time has an advantage, or it wouldn’t have lasted. Old AT&T, the American Telephone & Telegraph Company founded by the inventor Alexander Graham Bell in 1887, remained unchallenged until 1984, even though it had numerous problems and lots of unhappy campers as customers. How did it survive so long? Its advantage was that it was a government-sanctioned monopoly. That helped.

Competitive advantage means exactly what it says; a company has some sort of advantage over the competition. Where does it come from? Usually out of the distinct and special value that the company can offer its customers — and from the premium that customers place on that value. Ask yourself this basic question:

Why do customers choose my company and its products when other competitors in the industry have more-or-less similar offerings?

You can find the answer in the strongest links of your value chain — the links that produce the bulk of your customer value. Location, service, brand image, collaboration with ecosystem partners, and unique product features are some of the links that create a competitive advantage in the marketplace.

Focusing on core competence

You create your competitive advantage in the marketplace. Your advantages have everything to do with your customers — with the relative value that they place on your products and services and with the purchase decisions that they finally make. What internal capabilities and resources do you have, and what business activities do you engage in that lead directly to your competitive advantage? You must make sure to capture these in your business plan.

Go back to your company’s value chain (which we discuss in the earlier section “Describing What You Do Best”) and focus on the links that provide your competitive advantage. When you do, you come face to face with something that the gurus call your core competence. Simply defined, core competence is your company’s special capability to create a competitive advantage in the marketplace. In almost all cases, this gift is specific to your company. Think of core competence as being your business’s DNA. Unlike your personal genetic code, however, your company’s core competence is something you can build on — or lose, depending on how attentive you are to your marketplace and your business.

Amazon was started in a garage in Seattle, Washington, in 1994. But the unexpected rapid growth of the firm led to a confusing internal structure of tasks and responsibilities. Sometimes the left hand didn’t know what the right hand was doing, and there were issues with trying to scale rapidly to meet demand. Amazon realized that it had to start fixing its digital operating system (OS), or growth would stall. Then, beginning around 2000, Amazon decided to partner with third-party merchants so they could build online shopping sites on top of its own OS, creating shared revenue opportunities for both. This initiative seemed to go well.

Coincidentally, in 2003 senior executives convened for a short retreat at founder Jeff Bezos’s home to discuss Amazon’s “core competence.” This powwow, however, soon turned into a longer meeting and led to the realization that in fact, Amazon had become highly skilled at running reliable, scalable, cost-effective data centers. Given that its business was low-margin, the operating systems had to be as lean and efficient as possible. At that point the light bulb went on, and the firm began to lay the foundation for the establishment of Amazon Web Services (AWS), the cloud computing service it launched in 2006. AWS now offers its IT capabilities to firms and governments worldwide. In recent years the unit accounted for under 15 percent of Amazon’s total revenue — but was the source of almost 65 percent of Amazon’s total operating profit. So who’s your daddy, Amazon?

A company’s core competence can point the way toward new market opportunities. In the Amazon example, the firm’s relatively small IT service provider AWS became the profit driver for the entire company. Honda, the Japanese maker of all things that are powered by gasoline, realized that its core competence was in designing and manufacturing engines. The company created product lines in lawn mowers, snow throwers, snowmobiles, and all-terrain vehicles, to name just a few of its motor-based businesses besides its traditional motorcycles and cars. Honda benefits from a common competitive advantage (state-of-the-art engines) in each of these different markets. Take another look at your company’s core competence to see whether you can come up with any new business directions based on your existing skills and capabilities.

Sustaining an advantage over time

Every company that manages to stay in business has some sort of competitive advantage and core competence to draw upon; otherwise, it simply can’t exist. But here comes the million-dollar question: How can you renew and sustain that competitive advantage over time? Customers and their needs shift constantly as competition gets more intense, new technologies are innovated, and industries evolve. One respected business academic estimated that in the rapid-fire world of 21st-century commerce, a firm’s advantage lasted no more than three or four years. When you think about it, your competitive advantage and the core competence that supports it aren’t guaranteed to stay around. You rent them; you don’t own them. You want to make sure that you keep a long-term lease on both.

Sustained competitive advantage — the business world’s Holy Grail — is a company’s capability to renew competitive advantages over and over again in the face of a constantly changing business environment and marketplace. But if you want to sustain competitive advantages over time, you need to have a long-term strategy in place. Unfortunately, few do. Chapter 8 introduces three common alternatives called generic strategies and gives you a handle on what your competitors may be up to. Chapter 14 takes a much closer look at your strategic options. And Chapter 15 gives you some examples of what we term FD&H companies: fat, dumb, and happy. These firms achieved success but began to think they lived in a static world — and paid the price for their arrogance.

Spend some time thinking about strategies that your company can use on an ongoing basis to see that you preserve your core competence. How can you sustain the competitive advantage that your company already has? Upload a blank Word doc and provide answers to these key questions:

• Where will changes in your business most likely come from?
• How are those changes likely to affect your company’s competitive advantage?
• What can your company do to maintain core competence in the face of change?

Focus on each of the major forces that fuel change in your industry:

• Your customers and their changing needs and requirements
• Your competitors and their changing capabilities, strategies, and goals
• Your company, its value chain, and its shifting strengths and weaknesses

As you create your business plan, make sure that you continue to track these forces so that they don’t threaten the core competence you work so hard to achieve.