The true purpose of a value chain is to create value for the end customer.
In a recent article, I introduced the concept of value chains: the daisy chain of suppliers and customers, linked together to serve the end customer. The concept of a value chain says: your customer has a customer, who has a customer, and so on, until we reach the end customer.
This means that every firm within the value chain must contribute in some way to the sum total of value created. Value chains have an unwritten law: if a firm is not adding value to its customer, this firm will be eliminated or replaced by another entity. Let me give an example.
Let us say a company sells laboratory equipment (microscopes, reagents, etc.) to laboratories, through distributors. It has sold this way for a number of years, adding only incremental value to the end customer by making changes to the product, as dictated by technological advances.
Life is good for many years. Then, more competitors enter the marketplace, offering the same product and imitating each other – a process called isomorphism in the strategy literature. The end result is that the marketplace becomes commoditized, prices drop, and customers become indifferent to which brand they buy.
What happens next is very predictable. The purchasers go online, to Amazon Business, and some distributors go out of business. I have been telling my clients for a number of years about Amazon’s potential to get into the B2B space and disrupt traditional suppliers.
So, the lesson is clear: add value for your customers or die. The choice is yours.
Value chains offer us not only a stark lesson on survival but also show us how to create value for our customers. Up to this point, I have written about value chains as a collection of suppliers and customers. However, value chains also flow through a customer. This internal value chain shows us how to de-commoditize our business by showing us how to add value for our customer, beyond the core product. Let me share an example with you, from my forthcoming book.
Let us consider a supplier of toy parts, who sells to a toy manufacturer, who sells to a toy retailer (higher end retailer, not a discount chain), who sells to the end customer. The value chain is shown below.
Toy parts supplier >> toy manufacturer >> toy retailer >> end customer
Without a knowledge of value chains, the toy supplier adds value for his customer by supplying quality toy parts, on time and competitively priced. Readers of my articles will immediately recognize the danger that will eventually befall the toy parts supplier: those elements of value are basic, and they become the price of entry into the industry, as all competitors eventually offer the same set of value propositions.
With a knowledge of value chains, the toy parts supplier recognizes that the toy manufacturer has an internal value chain: a combination of steps that the toy manufacturer must perform to get the toy ready for sale to the retailer and add value beyond the sale. These steps are purchasing of materials, assembling (manufacturing) toys, marketing and sales, and after-sales service.
Therefore, the internal value chain is:
Purchase of materials >> toy assembly >> marketing and sales >> after-sales service
If the toy parts vendor pays close attention to the customer’s value chain, many areas for customer value creation manifest themselves.
Previously, the toy parts vendor would have added no value beyond the actual supply of toy parts. Now, the toy parts vendor can create value by simplifying the purchasing process for the customer, thereby reducing the customer’s costs of purchasing and parts acquisition. Further, the toy parts vendor can help the customer reduce material waste by studying the customer’s materials purchasing and handling process. A supplier I know helped its customers reduce how much paint they bought by showing them how to create innovative new colours by innovatively mixing and matching paints.
An examination of how the toy manufacturer assembles toys might reveal, for example, that the toy parts supplier can take over the paint shop operations, thus enabling the toy manufacturer to focus on toy assembly and innovation, thus saving the customer money.
The value chain forces the toy parts supplier to venture into territories where it might previously have never thought of going into. For example, the value chain forces the toy parts supplier to ask: how can I help my customer with marketing and sales? At first blush the idea may seem strange, even absurd. But deeper reflection would reveal that the toy parts supplier can help the toy manufacturer with enhanced marketing and sales materials and use his knowledge of segmentation to help his customer find market segments she may not have targeted before.
Many product lines the toy retailer carries are high end. An alert toy parts vendor would recognize that his customer faces stiff competition from national chain (discount) retailers who can sell toys more cheaply. The key question he should ask is: what can I do to help my customer differentiate and compete against lower-priced competitors? The value chain provides the answer by revealing that offering custom touch up paints or decals to customize toys are one way the toy retailer can differentiate herself from her competitors and build a loyal customer base.
Bottom line: draw the value chain for your own business, and examine which firms are adding value and which ones are not. This will enable you to predict the future trajectory of your industry, arming you with prescient knowledge to ensure your own long-term success by creating value for your customer.
Ajay Sirsi is a marketing professor in the Schulich School of Business at York University and facilitator for the Schulich Executive Education Centre’s Marketing Strategy for Competitive Advantage program (starting March 1, 2021). For more information and to register, visit the program web page today.