Harvard Business School's Michael E. Porter introduced the concept of a value chain in his book, "Competitive Advantage: Creating and Sustaining Superior Performance," in 1985. In his book he writes:
"Competitive advantage cannot be understood by looking at a firm as a whole," Porter wrote. "It stems from the many discrete activities a firm performs in designing, producing, marketing, delivering and supporting its product. Each of these activities can contribute to a firm's relative cost position and create a basis for differentiation."
Porter believed that competitive advantage comes from: (1) cost leadership, and (2) differentiation. Value chain analysis (VCA) helps to understand how both affect margin.
Value chain analysis considers the contribution of an organization's activities towards the optimization of margin, where margin is an organization's ability to deliver a product or service for which the customer is willing to pay more than the sum of the costs of all activities in the value chain.
Porter argues that a company can improve its margin by the way "primary activities" are chained together and how they are linked to supporting activities. He defines "primary activities" as those that are essential to adding value and creating competitive advantage. Furthermore, secondary activities assist the primary activities to maintain or enhance the product's value by means of cost reduction or value improvement. This the domain of LEAN and operational excellence.
An example value chain along with general processes are shown in the following diagram:
A Compliance Perspective
In recent years, compliance has increased in both complexity as well as demand by regulation and industry standards. It is, therefore, worth taking another look at the value chain in terms of how compliance should now be considered.
Porter includes the quality assurance (QA) function as part of the "Firm Infrastructure." At a basic level, this places QA outside of the core processes and considered as means to improve value and reduce cost. The latter, is the more common emphasis as many organizations view quality and other compliance functions as an overhead that needs to be reduced.
For the purpose of this discussion, we will use the same primary activities from the typical value chain. However, infrastructure activities are expanded to include other compliance activities such as: quality, safety, environmental and ethics & compliance.
Compliance activities can in principle contribute to value improvement as well as cost reduction. Although, the effects may not be direct or immediate. A key role of compliance is to drive down risk which as we know has effects that may be delayed or mitigated. Therefore, instead of margin, it might be more useful to consider the level of risk as the measure to be optimized.
It is common for compliance to be organized into isolated functions that are separate from the primary activities. However, we know that these programs are not effective when implemented in this way. Instead, they are more effective when seen as horizontal capabilities that cross the entire value chain.
The following diagram illustrates how a compliance chain can be constructed using Porter's value chain as a model:
By analyzing the relationship between compliance and primary activities (including secondary), it is possible to gain a better understanding of the following:
Cost of compliance and non-compliance
How and to what degree compliance affects risk
Value of compliance (cost avoidance, increased trust, and reduction in: defects, incidents, fatalities, financial losses, etc)
Strategies aligned with competitive advantages can then be applied to improve both margin as well drive down overall risk:
Cost Advantage
Porter argued that there are 10 drivers that improve cost advantage:
Create greater economies of scale
Increase the rate of organizational learning
Improve capacity utilization
Create stronger linkages between activities
Develop synergies between business units
Look to increase vertical integration
Improve the timing of market entry
Alter the firm’s strategy regarding cost or differentiation leadership
Change the geographic location of the activities
Look to address institutional factors such as regulation and tax efficiency
Differentiation Advantage
Porter further identifies 9 factors to promote unique value:
Changing policies and strategic decisions
Improving linkages among activities
Altering market timing
Altering production locations
Increase the rate of organizational learning
Create stronger linkages between activities
Develop relationships between business units
Change the scale of operations
Look to address institutional factors such as regulation and product requirements
Compliance Advantage
We suggest 10 principles to drive compliance advantage:
Keep all your promises
Take ownership for all your compliance obligations (required and voluntary)
Develop programs and systems that always keep you in compliance
Incrementally and continuously improve your compliance
Make compliance an integral part of your performance and productivity processes
Use proactive strategies to always stay in compliance
Monitor in real-time the status and your ability to stay in compliance
Audit outcomes of your compliance programs not activity
Develop a learning culture around compliance
Always strengthen your ability to easily meet and maintain compliance
Summary
Value chain analysis (VCA) has been used successfully to help companies create both cost and differentiation advantage to improve their margins. In today's highly regulated marketplace, tools like VCA can also be used to create a compliance advantage to decrease overall risk. While, this may not result in immediate cost reduction, it can avoid future costs and differentiate a company from its competitors by achieving: higher quality, safer operations, and improved trust from their stakeholders.
