With more than 27 million ecommerce sites, it's more important than ever to stand out in this crowded marketplace. One way to do so is by using the value chain framework to identify opportunities to lower costs or improve quality. Here’s how you can conduct your own value chain analysis to gain a competitive advantage in the fast-growing ecommerce landscape.
What is a value chain?
A value chain is a sequence of steps that allow a company to bring a final product or service to a customer. Value chains encompass all the company's business activities that add value to a finished product or service. This includes initial product research and development all the way through distribution and customer service.
Harvard Business School professor Michael E. Porter coined the term “value chain” in his 1985 book, Competitive Advantage: Creating and Sustaining Superior Performance. He argues that optimizing your value chain can deliver value to your customers in two primary ways:
- Lowering the costs of your products
- Creating higher quality products for your customers
Elements of a value chain
In his book, Michael breaks down the value chain into nine elements, or “value chain activities.” He then divides these elements into five primary and four secondary activities. Primary activities relate directly to operating your company’s production and distribution, whereas secondary activities—also called support activities—are systems upholding them.
For example, a paid advertising campaign for a dropshipping company is a primary activity because it ensures the company’s products reach potential customers. Running campaign management software, on the other hand, is a secondary activity because it supports the company’s paid ad campaign.
Here are all nine value chain activities:
Primary activities
- Inbound logistics. This activity ecompasses the process of sourcing, receiving, and storing raw materials or products from suppliers.
- Operations. This activity involves the production process of turning raw materials into finished products. Its associated costs include labor and machinery.
- Outbound logistics. Outbound logistics are the processes involved in distributing a product to the customer. It includes inventory management and order fulfillment processes like shipping logistics.
- Marketing and sales. This activity involves presenting your products to your audience and converting them to customers. It includes lead qualification, advertising campaigns, and pricing strategies.
- Service. This activity includes post-purchase support for customers such as customer service, product training, installations, warranties, and product repairs.
Secondary activities
- Firm infrastructure. Firm infrastructure encompasses all of the costs involved in managing your company’s systems and making business decisions. It includes accounting, management, and legal costs.
- Technology development. This includes costs going into technology systems designed to improve efficiency and conduct product research and development. It includes process automation software tools like warehouse management systems and customer relationship management (CRM) technologies.
- Human resource management. This includes costs associated with hiring and managing employees, from recruitment and training through employee relations, compensation, and benefits.
- Procurement. Procurement involves the processes for obtaining the resources and materials necessary to create a product, as well as supporting materials like office supplies.
What is value chain analysis?
Value chain analysis is a systematic evaluation of your company’s entire value chain. The primary goal of a value chain analysis is to identify how much value is created by each of your primary and support activities and determine each activity’s associated costs.
By creating a value chain model, you can identify ways to reduce costs and generate the most value possible for customers in each element of your value chain. This increases your competitive advantage and profit margins.
How to conduct a value chain analysis
- Select a value chain analysis template
- Identify value chain activities
- Find the costs associated with each activity
- Define the value associated with each activity
- Identify competitive advantage opportunities
Here are the steps you can take to conduct a value chain analysis for your own business. If your company sells multiple products, you’ll need to conduct a specific value chain analysis for each one, as the costs and values will differ depending on the product.
1. Select a value chain analysis template
Value chain analysis templates provide the simplest starting point for a value chain analysis. By using a detailed template that breaks down each value chain activity—both primary and supporting—you can jump-start the process of conducting a value chain analysis. Shopify offers a comprehensive free template that you can use to get started.
2. Identify value chain activities
Your first practical step is to map your value chain. Consider all primary and secondary activities involved in bringing your product to market, and list them on your template.
3. Find the costs associated with each activity
Once you have your value chain mapped out, you can start identifying specific cost drivers—the direct causes of your expenses—for each activity. For example, cost drivers for human resource management could include ads for recruitment, payroll for employees, and the cost of creating training materials. Reference expense reports or expense tracking apps to make sure you’re accounting for all of the costs associated with each element of your value chain.
4. Define the value associated with each activity
Once you’ve calculated the costs of your value chain activities, identify the value of each. You can do this with quantitative data like customer retention rate (CRR) and customer satisfaction score (CSAT)—as well as qualitative data like customer surveys. For example, you might identify that customer support initiatives like a customer loyalty program and a no-questions-asked return policy have increased customer loyalty and retention rates, ultimately adding value by increasing sales with more repeat customers.
5. Identify competitive advantage opportunities
After identifying the costs and values, look for areas where you can make improvements to gain a competitive advantage. Two primary strategies for developing a competitive advantage include creating a cost advantage and differentiation advantage.
You can create a cost advantage by lowering costs in your value chain and passing those cost savings on to your customers. You can create a differentiation advantage by increasing the quality of your products to a level that justifies a premium price your customers are willing to pay.
For example, let’s say you run a natural chewing gum brand and you identify materials and shipping as significant cost drivers (you’re sourcing mastic resin from Greece). By finding a domestic spruce resin supplier and using a blend of spruce and mastic gum, you could offer a more affordable product with comparable benefits, thus improving your value chain.
Benefits of a value chain analysis
Conducting a value chain analysis can benefit your company in a variety of ways, including:
Increased value for customers
The primary purpose of performing a value chain analysis is to determine how you can increase the value of your offerings by providing either less expensive or higher-quality products. You can use value chain analysis to optimize your primary and support activities to reduce costs or develop premium products, which can ultimately improve customer satisfaction.
Imagine you identify a production issue in the operations phase of your value chain that is causing minor product defects. After identifying the problem, you can implement quality control mechanisms to avoid future defects and ultimately deliver higher-quality products.
Optimized budgets
A value chain analysis is a useful tool for identifying where you can increase profit margins through cost reduction strategies. By mapping out all your costs on a value chain analysis template, you have a bird’s-eye view of your expenses. For example, you might notice your distribution costs are unusually high and develop strategies for reducing shipping costs. In this case, if you’re a Shopify merchant, you could decide to use Shopify Shipping, a built-in shipping software designed to optimize your shipping expenses through discounts up to 88% from major carriers like UPS and USPS.
Opportunities for innovation
Value chain analyses can also help you identify opportunities for innovation across your company’s activities. Imagine you’re running an ecommerce company selling running shoes, and you’ve identified the material you use for the soles of your shoes is relatively low-quality. You could then use this information to perform research and development on a new sustainable material for the soles that could ultimately provide your customers with a better product.
Value chain analysis FAQ
What are the different types of competitive advantage?
The two main types of competitive advantage include cost advantage—which involves selling products or services at a lower cost than competitors—and differentiation advantage, which involves selling premium products that are different from competitors and therefore include a higher price.
What is an example of value chain analysis?
An example would be a snow jacket company creating a value chain analysis model of its primary and secondary activities and then using the model to find ways to improve its product. The company might recognize that its procurement costs are high due to working with many smaller suppliers and decide to switch to two large manufacturing partners instead.
How does value chain analysis work?
Value chain analysis works by examining the costs and value associated with each of your company’s primary and supporting activities. You can accomplish this by reviewing your financials as well as quantitative data like your customer retention rate and qualitative data like customer surveys. By making adjustments to parts of your value chain, you can improve end results—like customer retention.
