Value Chain Analysis: Estimating Costs For Achieving Competitive Advantage

Calculation of WIP

Table 1: Calculation of WIP

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Table 2: Cost of goods manufactured

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 Table 3: Calculation of finished inventory

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 Table 4: COGS

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The value chain is a model developed by Michael Porter that is used for describing the process through which the business receive raw material, adds value to the raw material for creating finished product and sell the end product to the customer. The companies conduct the value chain analysis in order to increase the efficiency of the chain by analyzing the steps that are required to create the product (Gereffi and Fernandez-Stark 2016). The primary aim is to create maximum value with the minimum possible cost thereby ensuring a competitive advantage. In the value chain, analysis the company breaks down the flow production into five different categories. The company has the opportunity to create competitive advantage in which of these categories by maximizing efficiency and minimizing cost (Mudambi and Puck 2016). The increasing profit is the goal of the value chain by ensuring that at each of the five points the benefit exceeds the costs associated with a product.  The cost can be minimized if the cost framework for every element of the value chain is analyzed. Therefore, it can be seen from the above discussion that the meaning of the value chain includes examination of areas that are related to costs that are incurred in the business.

 The Value Chain Analysis is a strategic planning tool that is useful for the managers to estimate cost for gaining competitive advantage. The competitive advantage is gained by achieving cost leadership strategy by offering the lowest cost of the product. The correct estimation of cost plays an important role in achieving the cost leadership strategy. The value chain has a significant role in estimating the costs. In the approach of cost leadership the organization aims to gain an understanding on the sources of the cost advantages or disadvantages and the factors that drives the cost. The principal steps that an organization undertakes for analyzing or estimating internal cost are:

• The identification of the value creation process of the business. It involves identification of primary and secondary activity of the business.
• The importance of different activities in the total cost of the activity should be established.
• The cost drivers for each of the activities should be established.
• The link between different activities should be identified.
• The opportunities should be identified for reducing the cost.

The step above indicates that it is important to classify the total cost of the product into different activities. If the cost related to each activity is identified then it will be an easy process to reduce the cost by improving activities that are inefficient. Therefore, it can be said that classification of cost is helpful in estimating the cost of a product. It can be seen that the identification of the different drivers of cost is an important step for analyzing the internal cost. The understanding of factors that drives the cost helps the manager in focusing and improving those areas (Savino et al. 2015). The different activities have different cost drivers like wage rate, working hours etc. The analysis of drivers is an important step for estimating the total cost. Based on the above discussion it can be concluded that the value chain is helpful in classifying cost and in identifying cost drivers so it can be said to be useful in estimating the total costs.

Calculation of Cost of goods Manufactured

Dr. Michael Porter of Harvard Business School developed the concept of value chain. According to the developer of the concept, all activities from the initiation of a raw material to final conversion of it into a product or services are part of value chain. Primarily value chain activities can be segregated into two different segments these are namely,

Primary activities: These are primary activities, which are directly linked to the product development, or services that an organization is offering to its customers / consumers. Inbound logistics, operations, outbound logistics, marketing & sales, and services these are all part of primary activities.

Support activities: These are activities which are also essential to an organization for its operations however, these are not directly connected with the production and manufacturing neither with service generation. Infrastructure within the firm, management of human resources of an organization, research & development, technology and procurement are example of support activities. However, these are though not directly connected with manufacturing activities or service generation nevertheless important in the overall context.

It is important for the management to keep track of each single activities that are essential for an organization to function. Value chain theory by Porter has described the importance of recording and appraising each single expenditures whether these are of primary activities or support activities. Primary activities as is clear from the above explanation are mainly related to the production or service generation or both as the case may be of an organization as thus, the expenditures in relation to the primary activities will directly fluctuate with the quantity of production and service generation (Hollensen 2015). Thus, in most of the cases it is quite easy to keep track of such costs and expenditures whereas costs of support activities such as research & development expenditures, infrastructure related costs, technology costs, are not directly related with the production and service generation thus, often these are hard to record and maintain.

The information about all the different costs, whether of primary activities or of support activities, are of huge significance to the managers simply because managers are primarily responsible for the performance of an organization and the performance of an organization is very much dependent on the ability of an organization to use its resources efficiently and effectively. The information about each and every single cost will help the managers to assess whether the organization is on the right path as far as making optimum use of the available resources. Cost reduction is one of the basic objectives of the management along with increase in revenue; information about costs would help the management to assess whether the processes which are in use are efficiently using the resources. Information related to different costs will help the management to compare these with prior periods to check whether the costs have increased, reduced or been stable. In case the information about different costs suggests that the costs are rising then, the management will try to find the reasons for the same and will be able to take right steps to curve the increasing costs trend to achieve cost reduction in the future.

Calculation of Closing Finished Inventory

Alumina Limited is company listed in Australian Securities Exchange, here in after shall be referred to as ASX for the sake of brevity in this document. It is primarily involved in bauxite mining in different parts of the world along with alumina refining and alumina smelting activities. The annual report of the company for the year 2016 showed that the company has experienced a sudden spike in expenditures. A closer look would also help us to notice that the spike in expenditures are mainly due to the increase in expenditures that are of primary activities. The increase in costs primary activities such as bauxite mining, and minding of other natural materials. Along with mining expenditures, other costs such as inbound and outbound logistics have also increased significantly. Value chain analysis will help us to understand that the trend of increase in these expenditures are not something that the company is experiencing in recent times; rather it’s a long standing trend. A look at the earlier annual reports of the company will help us to understand the trend of increase in expenditures that are mainly related to primary activities.    The major purpose of value chain analysis is to identify the different segments in an organization the associated costs in these segments (Hollensen 2015). This analysis will help the management to identify the key activities that are absolutely essential to the production and service generation for an organization. Management based on the analysis will be able to take important decisions to improve the performance of an organization by achieving cost reduction at different stages in production and other related activities.

The value chain is not same for each and every company neither it is same for different industries thus, an organization which is involved in providing services will have different value chain to an organization which is in the manufacturing business. Similarly an organization in the automobile business will have different value chain as compare to an organization which is in the information and technology industry.

In case of Alumina Limited, it is primarily involved in bauxite mining and alumina mining; the management will have to use the value chain analysis to assess the reasons forever-increasing primary expenditures of the company. The use of value chain analysis will help the managers to identify the different primary activities that are mainly contributing in the increasing expenditures trend. This will help the management to assess the reasons for these expenditures to continuously rising at the cost of the company. Accordingly, the management should after assessing the reason should take necessary decisions to reverse the increasing expenditures trend. The management may decide to modify the mining operations by introducing new and improved technologies to reduce the overall mining costs in the future. The purpose of value chain is exactly to help the managers to achieve cost reduction by modifying primary and support activities after assessing the problem areas.   

Reference

Gereffi, G. and Fernandez-Stark, K., 2016. Global value chain analysis: a primer.

Hollensen, S., 2015. Marketing management: A relationship approach. Pearson Education.

Mudambi, R. and Puck, J., 2016. A global value chain analysis of the ‘regional strategy’perspective. Journal of Management Studies, 53(6), pp.1076-1093.

Savino, M.M., Manzini, R. and Mazza, A., 2015. Environmental and economic assessment of fresh fruit supply chain through value chain analysis. A case study in chestnuts industry. Production Planning & Control, 26(1), pp.1-18.