The Value of Understanding the Value Chain

Today we’re talking about the value chain and how important it is that you understand where whatever you offer falls on that value chain.

The value chain is essentially a list of your product’s stops along the production and distribution cycle with each stop being a place where someone adds value. For example, a silk scarf may start off with the silk worms themselves weaving the raw silk, which would be stop 1 and then move to a silk refiner where the raw silk is spun into silk yarn, which would be stop 2. From there, the silk yarn would be dyed at stop 3 and then woven into fabric at stop 4. Finally, it would be sewn into scarves and packaged for sale to distributors, which would be stop 5, who would then sell the completed scarves to retailers at stop 6 who then sell those scarves to the final consumer.

Each stop along the value chain is a place where someone adds value, hence the name value chain. Some stops add more value than others and give the controllers of those stops better profit margins. In order to most effectively plan your business, you need to know where your products and services fall along the value chain.

So, for each of your products or product lines you should:

  1. Identify the complete value chain of the product from the very initial components all the way through to the final consumer.
  2. Identify which stops on the value chain add the most value in the eyes of the consumer.
  3. Identify which stops along the value chain provide the highest profit margins.
  4. Identify where on the value chain your company falls.

Once you’ve done that, think about whether you’re located at the right spot on the value chain and if you may want to adjust your offerings slightly to improve potential profitability. If you’re located somewhere on the value chain where margins are slim, think about whether that’s where you really want to be as you move forward with building your business. Maybe you want to eliminate certain services completely or maybe you want to add more to generate better margins.

Taking the silk scarf value chain example from earlier a bit farther, if you currently spin the raw silk into silk yarn but you discover that those who dye the silk yarn generate huge profit margins, you may want to consider consolidating those two steps and spinning and dying the silk yarn. This is called vertical integration and simply means that a company is taking over multiple steps on the value chain and combining them under one roof. This is one way that companies may expand in the future, but even startups should consider where the best place on the value chain to be is and set up shop there to begin with.

 



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