Statements on Management Accounting

P R A C T I C E O F M A N A G E M E N T A C C O U N T I N G

C R E D I T S

T I T L E

This statement was approved for issuance as aStatement on Management Accounting by theManagement Accounting Committee (MAC) of theInstitute of Management Accountants (IMA). IMA appre-ciates the support of The Society of ManagementAccountants of Canada (SMAC) in helping create thisSMA and extends appreciation to Joseph G. SanMiguel, of the Naval Postgraduate School, who draftedthe manuscript.

Special thanks are due to Randoif Holst, SMACManager, Management Accounting Guidelines, for hiscontinuing project supervision and to the members ofthe focus group (including MAC members Dennis Dalyand Thomas Huff) for contributing to the improvementof the final document.

Value Chain Analysis for Assessing

Competitive Advantage

Published byInstitute of Management Accountants10 Paragon DriveMontvale, NJ 07645-1760www.imanet.org

Copyright 1996Institute of Management Accountants

All rights reserved

Statements on Management Accounting

T A B L E O F C O N T E N T S

Value Chain Analysis for Assessing Competitive Advantage

P R A C T I C E O F M A N A G E M E N T A C C O U N T I N G

I. Rationale . . . . . . . . . . . . . . . . . . . . . . . 1

II. Scope . . . . . . . . . . . . . . . . . . . . . . . . . 1

III. The Value Chain Defined . . . . . . . . . . . . .1

IV. Competitive Advantage and Customer Value . . . . . . . . . . . . . . . . . . .2

V. The Role of the Management Accountant . . . . . . . . . . . . . . . . . . . . . . .4

VI. The Value Chain Approach for Assessing Competitive Advantage . . . . . .5

Internal Cost Analysis . . . . . . . . . . . . . . .5

Internal Differentiation Analysis . . . . . . .10

Vertical Linkage Analysis . . . . . . . . . . . .13

VII. Strategic Frameworks for Value Chain Analysis . . . . . . . . . . . . . . .17

Industry Structure Analysis . . . . . . . . . .18

Core Competencies Analysis . . . . . . . . .19

Segmentation Analysis . . . . . . . . . . . . .22

VIII. Limitations of Value Chain Analysis . . . .26

IX. Organizational and Managerial Accounting Challenges . . . . . . . . . . . . . .27

X. Conclusion . . . . . . . . . . . . . . . . . . . . .28

Appendix Value Chain Analysis vs. ConventionalManagement Accounting

Bibliography

ExhibitsExhibit 1: The Value Chain . . . . . . . . . . . . . .3

Exhibit 2: Competitive Advantage Through Low Cost and/or Differentiation . . .4

Exhibit 3: Process Cost Drivers . . . . . . . . . . .8

Exhibit 4: Competitor Cost Analysis . . . . . . .10

Exhibit 5: Value Chain for Crown, Cork and Seal Company . . . . . . . . . . .12

Exhibit 6: Vertical Linkages in the Production of Plastic Food Containers . . . . . .13

Exhibit 7: Value Chain Differences: TheTelecommunications Industry . . . .16

Exhibit 8: How Tetra-Pak Reconfigured the Value Chain . . . . . . . . . . . . .21

Exhibit 9: How IKEA Reconfigured the Furniture Industry . . . . . . . . . . . .22

Exhibit 10: Approaches to DefiningSegmentation Variables . . . . . . . .24

Exhibit 11: Segmenting the British Frozen Food Industry . . . . . . . . . .25

Exhibit A-1: Value Chain vs. ConventionalManagement Accounting . . . . . . .30

I . RAT IONALECompetitive advantage for a company means notjust matching or surpassing what competitorscan do, but discovering what customers want andthen profitably satisfying, and even exceeding,their expectations. As barriers to interregionaland international trade have diminished and asaccess to goods and services has grown,customers can locate and acquire the best ofwhat they want, at an acceptable price, whereverit is in the world. Under growing competition and,hence, rising customer expectations, a companyspenalty for complacency becomes even greater.

A strategic tool to measure the importance ofthe customers perceived value is value chainanalysis. By enabling companies to determinethe strategic advantages and disadvantages oftheir activities and value-creating processes inthe marketplace, value chain analysis becomesessential for assessing competitive advantage.

I I . SCOPEThis guideline is addressed to managers, andmore specifically to management accountants,who may lead efforts to implement value chainanalysis in their organizations.

The concepts, tools and techniques presentedapply to all organizations that produce and sell aproduct or provide a service.

This guideline will help readers to:

l link value chain analysis to organizationalgoals, strategies and objectives;

l broaden management awareness about valuechain analysis;

l understand the value chain approach forassessing competitive advantage;

l comprehend useful strategic frameworks forvalue chain analysis; and

l appreciate the organizational and managerialaccounting challenges.

I I I . THE VALUE CHAIN DEF INEDThe idea of a value chain was first suggested byMichael Porter (1985) to depict how customervalue accumulates along a chain of activitiesthat lead to an end product or service.

Porter describes the value chain as the internalprocesses or activities a company performs todesign, produce, market, deliver and support itsproduct. He further states that a firms valuechain and the way it performs individual activitiesare a reflection of its history, its strategy, itsapproach to implementing its strategy, and theunderlying economics of the activities themselves.

Porter describes two major categories of busi-ness activities: primary activities and supportactivities. Primary activities are directly involvedin transforming inputs into outputs and in deliveryand after-sales support. These are generally alsothe line activities of the organization. Theyinclude:

l inbound logisticsmaterial handling and warehousing;

l operationstransforming inputs into the finalproduct;

l outbound logisticsorder processing and dis-tribution;

l marketing and salescommunication, pricingand channel management; and

l serviceinstallation, repair and parts.

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Support activities support primary activities andother support activities. They are handled by theorganizations staff functions and include:

l procurementpurchasing of raw materials,supplies and other consumable items as wellas assets;

l technology developmenknow-how, proceduresand technological inputs needed in every valuechain activity;

l human resource managementselection,promotion and placement; appraisal; rewards;management development; and labor/employeerelations; and

l firm infrastructuregeneral management,planning, finance, accounting, legal, governmentaffairs and quality management.

John Shank and V. Govindarajan (1993) describethe value chain in broader terms than doesPorter. They state that the value chain for anyfirm is the value-creating activities all the wayfrom basic raw material sources from componentsuppliers through to the ultimate end-use productdelivered into the final consumers hands. Thisdescription views the firm as part of an overallchain of value-creating processes.

According to Shank and Govindarajan, the industryvalue chain starts with the value-creatingprocesses of suppliers, who provide the basicraw materials and components. It continues withthe value-creating processes of different classesof buyers or end-use consumers, and culminatesin the disposal and recycling of materials.

The industry value chain and the value chainactivities within the firm are compared in Exhibit 1.

IV. COMPETIT IVE ADVANTAGEAND CUSTOMER VALUEIn order to survive and prosper in an industry,firms must meet two criteria: they must supplywhat customers want to buy, and they must survive competition. A firms overall competitiveadvantage derives from the difference betweenthe value it offers to customers and its cost ofcreating that customer value.

Competitive advantage in regard to products andservices takes two possible forms. The first is anoffering or differentiation advantage. If customersperceive a product or service as superior, theybecome more willing to pay a premium price relative to the price they will pay for competingofferings. The second is a relative low-costadvantage, which customers gain when a companys total costs undercut those of its average competitor.

Differentiation AdvantageA differentiation advantage occurs when customersperceive that a business units product offering(defined to include all attributes relevant to thebuying decision) is of higher quality, incurs fewerrisks and/or outperforms competing productofferings. For example, differentiation may includea firms ability to deliver goods and services in atimely manner, to produce better quality, to offerthe customer a wider range of goods and services,and other factors that provide unique customervalue.

Once a company has successfully differentiatedits offering, management may exploit the advan-tage in one of two ways: increase price until itjust offsets the improvement in customer benefits,thus maintaining current market share; or pricebelow the full premium level in order to buildmarket share.

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Low-Cost AdvantageA firm enjoys a relative cost advantage if its totalcosts are lower than the market average. Thisrelative cost advantage enables a business todo one of two things: price its product or servicelower than its competitors in order to gain marketshare and still maintain current profitability; or match the price of competing products or services and