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Cost Management-final                                                                                                       5

THE VALUE CHAIN APPROACH FOR ASSESSING COMPETITIVE ADVANTAGE

Most corporations define their mission as one of creating products or services. For these organizations, the products or services generated are more important than any single step within their value chain. In contrast, other companies are acutely aware of the strategic importance of individual activities within their value chain. They thrive by concentrating on those activities that allow them to capture maximum value for their customers and them­selves.

These firms use the value chain approach to better understand which segments, distribution channels, price points, product differentiation, selling propositions and value chain configura­tions will yield them the greatest competitive advantage.

The way the value chain approach helps these organisations to assess competitive advan­tage includes the use of following steps of analysis :

(i)

Internal cost analysis — to determine the sources of profitability and the relative cost positions of internal value-creating processes;

(ii)

Internal differentiation analysis— to understand the sources of differentiation (in­cluding the cost) within internal value-creating processes; and

(iii) Vertical linkage analysis — to understand the relationships and associated costs among external suppliers and customers in order to maximise the value delivered to customers and to minimise cost.

These types of analysis are not mutually exclusive. Rather, firms begin by focusing on their internal operations and gradually widening their focus to consider their competitive position within their industry.

The value chain approach used for assessing competitive advantage is an integral part of the Strategic planning process. Like strategic planning, value chain analysis is a continuous process of gathering, evaluating and communicating information for business decision-making.

By stimulating strategic thinking, the analysis helps managers envision the company's future and implement decisions to gain competitive advantage.    

Internal Cost Analysis : Organisations use the value chain approach to identify sources of profitability and to understand the cost of their internal processes or activities.

The principal steps of internal cost analysis are :

1.Identify the firm's value-creating processes.

2.Determine the portion of the total cost of the product or services attributable to each value-creating process.

3.Identify the cost drivers for each process.

4.Identify the links between processes.

5.Evaluate the opportunities for achieving relative cost advantage.

Now we shall discuss each step:

1. Identify the firm's value-creating processes : To identify a firms value-creating processes, the firm must de-emphasize its functional structure. Most large businesses still organise themselves as cost, revenue, profit and investment centers. These and other organisational sub-units, such as departments, functions, divisions or separate companies, that are frequently used for control purposes are not very useful for identifying value-creating processes. Adopting a process perspective requires a horizontal view of the organisation, beginning with product inputs and ending with outputs and customers.

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