The Creation of Value
The Creation of Value
The purpose of this essay is to understand the ideas and theories of competitive advantage, as defined by Porter (1985), and show how these concepts are integrated into industry and adopted at different stages of Porters value chain, paying particular attention to the importance of the secondary activities.
In order for a firm to survive within industry there has always existed the need for it to distinguish itself from its rivals. In order to achieve a prominent status within the market one of the main objectives within all business is the creation and sustaining of a higher profit margin than the average for its industry. When a business does this it is said to have achieved a competitive advantage. A business can compete for this in one of two ways, either through differentiation of through cost leadership. When a business decides to compete on a cost level they are attempting to become the low cost producer within their industry, essentially providing the cheapest product. The key to gaining a successful advantage through cost leadership is to make sure the product or service provided is comparable to its rivals, thereby allowing the company to charge a competitive market rate and still create a high and sustainable profit margin. The other aspect of competitive advantage is differentiation.
The key to gaining a competitive advantage through differentiation is to understand the specific needs of the customer and develop certain attributes to meet those needs, for if a business can increase the customer perception of their product then they can charge a higher price but still compete within the market. There are many examples of different industries competing for a competitive advantage through both of these strategies. For instance, within the clothing industry a company such as Primark would be the embodiment of cost leadership. They are a hugely successful, multi national company that market themselves expressly on their super competitive prices, employing the tagline “Look good, pay less” and winning numerous awards for both fashion and value, arguably perhaps the most important aspects of cost leadership within the clothing sector. Competing on a differentiation basis would be a company such as Coes of East Anglia.
They are a relatively small, independent company that pride themselves on the quality of their product and their customer service, offering services such as basic garment adjustments, home visits and personal shoppers whilst making sure that each member of staff has exceptional product knowledge. Coes also compete with other clothing retailers by specializing in certain areas such as extra large shoes, stocking sizes, up to and including, size 20. For these unique qualities Coes can charge above the average market price and still develop and maintain their customer base. These two strategies are not mutually exclusive however; companies do exist that use a hybrid technique utilizing, to an extent, both aspects of competitive advantage. The clothing company Madhouse has developed itself in this type of direction. Madhouse is a company that sells a range of designer branded clothes, such as Nike and Ye Saint Lauren, at competitive prices but also has a range of own branded products that could be classed as non-mainstream, therefore aiming at a more specific market.
In order to fully appreciate the basis of a competitive advantage a business must not be taken as a whole, to gain a more developed understanding the business must be broken down into its various different activities. Once you have an understanding of the operations that go on within the running of a business you can identify where either a cost leadership or a differentiation approach has been employed. The model most often used when analyzing these operations is Porters value chain model. Porter broke down the foundations of most businesses into nine key segments, five primary activities and four secondary activities. The dividing factor between the two is where primary activities directly create value; secondary activities support the primary, creating value, but not directly. The primary activities of a firm begin with the Inbound Logistics. This relates to the input of materials into the firm. An example of a firm competing on a cost basis at this level would be Argos. They stock an increasingly large and diverse range of products.
By minimizing on display space and other costly overheads they are able to sell their products at a lower price. Next in the chain comes Operations, these are the activities that alter the input materials into the final product and prepare them for the customer. The steps required to transfer the finished product to the customer are called the outbound logistics. Examples of competing on a differentiation level would be courier companies such as DHL who may charge a higher price than other courier services but pride themselves on the speed and reliability they provide. Another important aspect of the model is Advertising and Sales. These are the activities associated with getting the customer to purchase a particular product, be it the price of the product or the channel or magazine the product is advertised in. A current product that competes in this way would be the satellite navigation company Tom Tom. Who, although being a relatively new product onto the market, have become a dominant force within the industry due not only to the quality of the product but to the huge advertising campaigns they have run.
The final primary activity is the service that a company provides in order to enhance a products value. These can include benefits such as a high level of customer support and efficient repair services. Staying with the example of satellite navigation, another manufacturer, Garmin, compete on a differentiation level at this stage buy offering double the warrantee period of other manufacturers and having a seven day a week customer service line for both retail outlets and the customer. Equally as important, if not more so than the primary activities, are the secondary activities. These consist of the Procurement of the raw materials that are to be inputted into the value chain. An example of a company competing on a cost basis at this level would be Ikea, who purchase all materials in huge bulk and then sell at low prices. The Development of Technology is also a support activity as in many industries the development of process automation has benefited profit margins by reducing staff and all of the costly overheads that come with employing and supporting high staff levels.
However, staff are a valuable asset within all businesses and the activities associated with the recruiting, development and retention of employees is another key aspect of the value chain and is included under the title of Human Resource Management. A company competing on a differentiation level within this section would be Halfords. As a retail company they pride themselves of the expert knowledge of their staff when it comes to key sales areas such as in car technology and bicycles. In order to do this they offer training qualification, recognized throughout industry, not just specifically within Halfords. These qualifications include certifications from the Institute of the Motor industry. The final secondary activity incorporates all aspects of the firm infrastructure, including activities such as finance, quality management and the legal departments of a company. As a diagram, the Value chain seems fairly rigid, however this is not strictly the case, each industry is separate and therefore different aspects of the value chain apply more importantly than others.
It is also worth acknowledging that the value chain is not definite, not every aspect can apply to every kind of business. For example, technological development has not benefited the fast food industry in any major way since the invention of the microwave whereas customer service is absolutely essential. Furthermore, there are activities not included in the value chain that are seen as a crucial part of business, for example Public Relations. Many businesses rely on publishing company information and maintaining investor relationships in order to sustain their profitability. As mentioned before, the importance of the secondary activities can never be underestimated within business and it has become the function of good managers to understand this and act upon it. As an example of how the support activities can be utilized to create value, Halfords will again be looked at, with reference to the importance it places on support activities, namely the areas of Human Resources and Technology development As a business that utilizes both differentiation and cost advantage to compete in the market, it became clear to the company if they continued to cut costs then they would loose their basis of differentiation.
The solution they devised was to, with the help of British Telecom, develop and install a new computer system that would revolutionize they way they operated at a store level. To maintain a dominant presence within retail, the company understood that four key elements had to be improved: Customer service, store standards, the availability of non-stock items and quicker shelf replenishment of items kept on the shelves. Through a new computer system it was realized that shelf replenishment and the ordering process could be vastly improved. Through direct access to both external suppliers, head office and each individual stores stock levels, staff on the shop floor could advise customers to the availability of any particular item at any particular time, therefore increasing sales and improving customer service. The system was also designed to make other time consuming tasks such as stock counting, more efficient, freeing up staff to be on the shop floor and therefore available to the customer at all times. As a company they accessed their activities and realized that an improvement in the technical side of their trading could increase their value as a brand and improve their position within the retail industry.
Halfords also realized that the key to being a successful retail outlet was not only reliant on the products sold, but also in the manner in which they are sold. This made the need for superior product knowledge imperative if Halfords wanted to distinguish itself from its competitors. For that reason, Halfords developed training courses for staff in their three most specialized departments, that of bicycles, in car technology and child seats. Through the company staff can receive qualifications and certificates recognized nationally. These include up to an NVQ level three in Cycle Repair, an ‘Electronic Auxiliary Equipment Installation’ certificate accredited by the Institute of the Motor Industry and child seat fitting certificates run by all major child seat manufacturers including Graco, Britax and Maxi Cosi. Through providing staff with this high level of training, Halfords sought to maximize their competitive advantage and create barriers to encroachment from their competition.
With regards to bicycles, when Halfords launched their ‘We’ll Repair It’ initiative they saw it as an essential tool, not only to meet the needs of existing customers, but an important part of securing a new customer base. By having staff trained to the highest level of cycle repair, not only do customers get the very best service but when a customer brings in a cycle for repair, stores can sell both the replacement parts and charge labor, thus significantly increasing store sales. This in particular could be an ever increasing market as increased cycle sales can potentially lead to increased repair work.