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The Value Chain Essay

All of the functions of a company—such as production, marketing, product development, service, information systems, materials management, and human resources—have a role in lowering the cost structure and increasing the perceived value of products through differentiation.

As the first step in examining this concept, consider the value chain, which is illustrated in Figure 3.5.11 The term value chain refers to the idea that a company is a chain of activities that transforms inputs into outputs that customers value.

The transformation process involves both primary activities and support activities that add value to the product.
Primary Activities

Primary activities include the design, creation, and delivery of the product, the product’s marketing, and its support and after-sales service. In the value chain illustrated in Figure 3.5, the primary activities are broken down into four functions:

· research and development,
· production,
· marketing and sales,
· customer service.

Research and Development

Research and development (R&D) refers to the design of products and production processes. Although we think of R&D as being associated with the design of physical products and production processes in manufacturing enterprises, many service companies also undertake R&D. For example, banks compete with each other by developing new financial products and new ways of delivering those products to customers. Online banking and smart debit cards are two examples of the fruits of new-product development in the banking industry. Earlier examples of innovation in the banking industry included ATM machines, credit cards, and debit cards.

By creating superior product design, R&D can increase the functionality of products, making them more attractive to customers, and thereby adding value. Alternatively, the work of R&D may result in more efficient production processes, thereby lowering production costs. Either way, the R&D function can help to lower costs or raise the utility of a product and permit a company to charge higher prices. At Intel, for example, R&D creates value by developing ever more powerful microprocessors and helping to pioneer ever-more-efficient manufacturing processes (in conjunction with equipment suppliers).

It is important to emphasize that R&D is not just about enhancing the features and functions of a product, it is also about the elegance of a product’s design, which can create an impression of superior value in the minds of consumers. For example, part of Apple’s success with the iPhone has been based upon the elegance and appeal of the iPhone design, which has turned a piece of electronic equipment into a fashion accessory. For another ex-ample of how design elegance can create value, see Strategy in Action 3.1, which discusses value creation at the fashion house Burberry.

Production

Production refers to the creation process of a good or service. For physical products, this generally means manufacturing. For services such as banking or retail operations, “production” typically takes place while the service is delivered to the customer, as when a bank makes a loan to a customer. By performing its activities efficiently, the production function of a company helps to lower its cost structure. For example, the efficient production operations of Honda and Toyota help those automobile companies achieve higher profitability relative to competitors such as General Motors. The production function can also perform its activities in a way that is consistent with high product quality, which leads to differentiation (and higher value) and lower costs.

Marketing and Sales

There are several ways in which the marketing and sales functions of a company can help to create value. Through brand positioning and advertising, the marketing function can increase the value that customers perceive to be contained in a company’s product (and thus the utility they attribute to the product). Insofar as these help to create a favorable impression of the company’s product in the minds of customers, they increase utility. For example, the French company Perrier persuaded U.S. customers that slightly carbonated bottled water was worth $1.50 per bottle rather than a price closer to the $0.50 that it cost to collect, bottle, and distribute the water.

Perrier’s marketing function increased the perception of value that customers ascribed to the product. Similarly, by help-ing to re-brand the company and its product offering, the marketing department at Burberry helped to create value (see Strategy in Action 3.1). Marketing and sales can also create value by discovering customer needs and communicating them back to the R&D function of the company, which can then design products that better match those needs.

Customer Service

The role of the service function of an enterprise is to provide after-sales service and support. This function can create superior utility by solving customer problems and supporting customers after they have purchased the product. For example, Caterpillar, the U.S.-based manufacturer of heavy-earthmoving equipment, can ship spare parts to any location in the world within 24 hours, thereby minimizing the amount of downtime its customers have to face if their Caterpillar equipment malfunctions. This is an extremely valuable support capability in an industry where downtime is very expensive. The extent of customer support has helped to increase the utility that customers associate with Caterpillar products, and therefore the price that Caterpillar can charge for its products.

Support Activities

The support activities of the value chain provide inputs that allow the primary activities to take place. These activities are broken down into four functions:
materials management (or logistics),
human resources,
information systems,
and company infrastructure (see Figure 3.5).

Materials Management (Logistics)

The materials-management (or logistics) function controls the transmission of physical materials through the value chain, from procurement through production and into distribution. The efficiency with which this is carried out can significantly lower cost, thereby creating more profit. Dell Inc. has a very efficient materials-management process. By tightly controlling the flow of component parts from its suppliers to its assembly plants, and into the hands of consumers, Dell has dramatically reduced its inventory holding costs. Lower inventories equate to lower costs, and hence greater profitability. Another company that has benefited from very efficient materials management, the Spanish fashion company Zara, is discussed in Strategy in Action 3.2.

Human Resources

There are numerous ways in which the human resource function can help an enterprise to create more value. This function ensures that the company has the right combination of skilled people to perform its value creation activities effectively. It is also the job of the human resource function to ensure that people are adequately trained, motivated, and compensated to perform their value creation tasks. If the human resources are functioning well, employee productivity rises (which lowers costs) and customer service improves (which raises utility), thereby enabling the company to create more value.

Information Systems

Information systems are, primarily, the electronic systems for man-aging inventory, tracking sales, pricing products, selling products, dealing with customer service inquiries, and so on. Information systems, when coupled with the communications features of the Internet, are holding out the promise of being able to improve the efficiency and effectiveness with which a company manages its other value creation activities. Again, Dell uses Web-based information systems to efficiently manage its global logistics network and increase inventory turnover. World-class information systems are also an aspect of Zara’s competitive advantage (see Strategy in Action 3.2).

Company Infrastructure

Company infrastructure is the company-wide context within which all the other value creation activities take place: the organizational structure, control systems, and company culture. Because top management can exert considerable influence upon shaping these aspects of a company, top management should also be viewed as part of the infrastructure of a company. Indeed, through strong leadership, top management can shape the infrastructure of a company and, through that, the performance of all other value creation activities that take place within it. A good example of this process is given in Strategy in Action 3.1, which looks at how Rose Marie Bravo helped to engineer a turnaround at Burberry.


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