Porter identified the ‘value chain’ as a means of analysing an organisation’s strategically relevant activities in order to understand the behaviour of costs. Competitive advantage comes from carrying out those activities in a more cost effective way than ones competitors.
M. Porter (in Competitive Advantage, 1985) breaks the Value Chain (VC) model into two distinctive types: these being primary and support activities. The model suggests, that no matter how many operational units that are involved in the process of generating customer value; these primary activities can be conceptualized into five generic stages.
The five primary stages are inbound logistics, operations, outbound logistics, marketing and sales, and services. These primary stages are supported by the four secondary activities—infrastructure, human resource management, technological development and procurement.
The stages within the VC should not be seen in isolation but look at in a wider context and include the interactions between stages not just with processes. The relationship between sales, operations and procurement for instance can determine how much stock is to be carried and therefore reflected in cost of inventory held.
When analysing the VC of a given company the management accountant should firstly identify the activities of the firm to establish the framework of the chain.
For instance, a company producing computers and a firm of accountants for instance would display very different components within the chain due to the differentiating activities; this framework will allow us to establish the relevant importance of each unit of activity in regard to costs.
As you can see the relevance of operations within the manufacturing company is higher than that of operations within accountancy. With over 60% of its costs being allocated to operations, it would seem that the manufacturing company should concentrate on this area to maximise savings, as cost is the main driver.
The accountancy firm, however, has two main cost drivers, being operations at 26% and marketing at 21%, suggesting almost equal savings potential will be offered.
As in ABC, Management Accountant has to firstly identify the cost drivers which could be the costs of capital equipment, volumes of production, wage rates, rates of rejection due to quality defects. Porter identifies 10 ‘cost drivers’ the most quantifiable of these being economies, diseconomies of scale, learning or experience effects and capacity utilization.
Once these have been identified, the second step is to determine the scope for cost reduction. The use of value chain allows us to separate activities into their component parts, thus, allowing an organisation to achieve a firmer insight into the elements effecting costs. This enables to compare differences in the unit costs in the chain.
Within an organisation there are usually range of products that are sold to different segments/buyers, the result is that behaviour of costs within the chain may change accordingly. When using value chain analysis we must take these differences of cost behaviour amongst segments into account otherwise we run the risk of average costing or incorrect pricing, providing openings for our competitors.
The management accountant should be able to cost value chains of the company and its competitors. The value chain is concerned with the creation and accumulation of value instead of purely concerning itself in the addition of costs and margins.
Team effort is required to get the advantages of value chain analysis Now-a-days the management accountant of a company has to collaborate with engineering, production, marketing and distribution professionals to focus on the SWOT (i.e. strengths, weaknesses, opportunities and threats) identified in the value chain analysis results.
By advocating the use of value chain analysis, the management accountant enhances the value of the firm. He lays emphasis on the fact that use of value chain analysis is very important for decision making.