One of the more important strategic choices for a business is how it will organize itself and go about delivering value to its customers. Few firms have the capacity to be fully integrated and take responsibility for creating and delivering the entire product or service they sell. Even if a firm could do so, complete integration is rarely an optimal financial strategy.
Instead, most firms must identify partners, suppliers, distributors, retailers and others who can provide some of the necessary activities for the creation of value. The set of all activities necessary to deliver value to a consumer is referred to as the value chain. Considerable time, effort, and resources go into the identification and management of partners within the value chain. Much of this effort is appropriately led by procurement and sales functions, which focus on the coordination of the day-to-day activities necessary for conducting business. There is, however, a strategic dimension to managing the value chain that should be addressed by senior management. Curiously, most firms do not have a senior manager whose job is the strategic management of the entire value chain. In reality, the very definition of a firm’s brand and the customer experience it delivers rests on assuring that all activities in the value chain do, in fact, deliver value, and do so in a way that is consistent with the overall image the firm seeks to project.
Understanding Revenue And Cost Equations
Most often, planning of the value chain involve discussions of actual or potential organizational partners to provide supplies, deliver service, or distribute and sell a firm’s offerings. From a strategic planning perspective, this is not the place to begin. Rather, the firm needs to identify all of the activities required to deliver value to the customer. This means beginning with the customer to determine what the customer expects in the product or service they buy. It is the customer that establishes the total value of a firm’s offering based on what they are willing to pay. In this way two very important economic equations are established. The first equation is a revenue equation: what the customer is willing to pay establishes the revenue that must be divided among all partners contributing to the value delivered to the customer. The second equation is a cost equation that is defined by the totality of all the costs associated delivering the value expected by the customer. It is important to recognize that there need be no symmetry in these two equations. One of the partner firms in the chain may bear a disproportionate share of the total costs while another partner may take a disproportionate share of the revenue.
The way in which these two equations operate is well illustrated by the history of the desktop computer industry. There are a variety of activities that are required to deliver value to the end user customer. These activities include the manufacturing of component parts, assembly of the finished unit, distribution, and user support among others. Each of these activities has an associated cost and the share of the revenue each partner can command is based on the relative importance of the activities they provide. Thus, Intel, which creates the processor chip, can command a higher share of revenue, through higher margins on its products, than an assembler that offers more commodity like activities. In the early years of the industry, when computers and software were not customer friendly, a set of intermediaries arose, value added resellers, who provided set-up, training, and maintenance to customers. Such activities had value because most customers, whether individuals or organizations, had in-house expertise for dealing with desktop computers, and most computer manufacturers did not have the local service organizations necessary for delivering these activities. These resellers often bundled the cost of these activities into the margins they charged when selling computers directly to customers. Over time, some computer manufacturers began to sell in volume directly to organizational customers, often with large volume discounts, and to large discount chains selling directly to consumers, also at a deep discount. All great until the discounted prices squeezed out the value-added resellers, who have all but disappeared. And, the services they provided had to be delivered by manufacturers, through creation of service departments and computers that were easier to use and customer organizations who created their own IT support services for desktop computers. This transition proved highly disruptive, and a few brands did not fare well, but there were opportunities for savvy firms who understood the role of value-adding activities.
5 Questions For Managing The Value Chain
For the strategic firm there are a number of questions that require answers when thinking about the value chain. First, what activities are necessary to deliver value to a customer? Answering this question may reveal activities that the firm and its partners engage in that add no value and therefore could be eliminated. Second, who should provide the necessary activities that do add value? Which activities will the firm perform itself and which will it have partners perform? Third, what are the implications of the division of labor for the revenue and cost equations? Fourth, are there alternatives ways to organize the value chain that provide better returns for the firm or higher value for the customer. Finally, what do the answers to the first four questions imply about the brand identity of the firm’s offerings?
This type of analysis can quickly become very complex when a firm participates in multiple value chains with different end user customers, different required activities, and different sets of potential partners. Such analysis and the decisions that result need to be made by the most senior of managers in the firm who can bring a strategic vision to the organization of the value chain. They also imply a major role for marketing and brand management because they are at the heart of value delivery and brand identity.
Contributed to Branding Strategy Insider by: Dr. David Stewart, Emeritus Professor of Marketing and Business Law, Loyola Marymount University, Author, Financial Dimensions Of Marketing Decisions.
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