Value Chain Analysis For Cost Estimation And Business Improvement

Part 1

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In the current era, various organisations fail to accomplish the anticipated profits due to use of inappropriate models or methods for ascertaining the actual costs of products and services. Such failure to analyse the business costs accurately affects the profit margin as well as competitive advantage of the organisations. In order to evaluate whether an organisation is not able to realise optimum allocation of resources, it needs to look at the methodology that Michael Porter has popularised, which is known as value chain analysis. This method seeks to define the entire chain through which the products are supplied to the customers. Thus, value chain provides a valuable framework to investigate those areas, in which a business incurs cost (Langfield-Smith et al. 2017). This paper would explore the various aspects of the value chain analysis and the last section would emphasise on analysing the purposes of the value chain for Adelaide Brighton Limited, which is one of the leading ASX 100 companies in the manufacturing sector.

1.In the words of Chenhall and Moers (2015), value chain analysis is a method of segregating different business activities into primary and support activities along with analysing them by keeping in mind the contribution towards creation of value to the final product. In order to conduct the same, the inputs consumed by the activity and outputs generated are analysed for minimising costs and increasing differentiation. With the help of value chain analysis, it becomes possible to identify activities within and throughout the organisation along with associating these activities to competitive strength analysis.

Figure 1: Porter’s value chain analysis

(Source: Mudambi and Puck 2016)

From the above figure, the value chain is distributed into nine activities and all are associated with each other. The primary activities take into account those activities, which are carried out to meet external demand, while the secondary activities comprise of those activities conducted to meet the internal needs.

2.The gap between the costs of an organisation and the willingness of the customers to pay signifies the competitive advantage and profitability of the organisation (Cooper 2017). In order to increase profitability as well as competitive advantage, there are two alternatives available for an organisation. It could either undertake actions in restructuring its marketing, research and development and design activities for raising the willingness of the customers to pay or actions could be undertaken for minimising costs.

Part 2

Even though increasing the willingness of the customers to pay seems like an easy concept, it is extremely difficult to accomplish the same in reality than it sounds like in theory. The structure of the business model of an organisation, its market position, cash flow and available capital could restrict its capability of involving in activities having the potential of increasing the willingness of the customers to pay (Cooper 2017). Even when there is existence of these resources, it is not possible to ensure a tangible return on investment.

By keeping in mind all these reasons, there are a number of organisations that prefer choosing cost minimisation rather than increasing the willingness of the customers to pay. When the costs of an organisation are understood and evaluated appropriately, depict the piece of the equation of competitive advantage, which the organisation could control to a particular extent. Therefore, one effective technique for cost analysis is to investigate the costs related to each step of the value chain of the organisation. The following diagram illustrates a generic value chain for a manufacturing organisation and the steps necessary for applying the value chain to estimate costs:

Figure 2: Value chain for a manufacturing organisation

(Source: Grant 2016)

Step 1: Identification of the main activities constituting of the value chain

Step 2: Allocation of overall costs to all functions throughout the value chain

Step 3: Identification of cost drivers within function of each value

Step 4: Identification of linkages like the effect of change in one functional area on the other areas

Step 5: Formulation of strategies for minimising costs

The benefit obtained by linking value chain in cost estimation is that cost minimisation strategies are kept consistent throughout the organisation. For instance, by looking at the goods inventories from the above diagram, cost saving strategies could be developed easily and effectively within that value function; however, detract from the consistency of the organisational strategy. It is obvious that cost saving strategy needs trade-offs at various value chain levels (Malmi 2016). However, by viewing cost savings with the help of value chain lens, the managers could be able to make trade-offs in those areas minimising most significant costs with little impact on value added by function or the overall organisational strategy.

3.The value chain consists of two segments, which include primary activities and support activities. The primary activities are listed down as follows:

These include all processes engaged in storing, receiving as well as internal distribution of raw materials or primary ingredients of products or services. The association with the suppliers is necessary for creating value in this respect.

These include all activities like production line or production floor converting inputs of products into finished or semi-finished products. Operating systems are deemed to be the guiding doctrine for value creation for the managers.

These take into account activities associated with delivering products and services to the customers (Nielsen, Mitchell and Nørreklit 2015). For instance, the managers could obtain cost information related to distribution, storage and transport.

These include all the procedures associated with placing the products and services in the market along with handling and generating relationships with the customers. The guiding principles are setting apart from competition along with developing benefits for the customers.

Service comprises of all the activities in order to maintain the product or service values to the customers as soon as association is developed depending on the procurement of products and services. With the help of this aspect, the managers could gain an understanding of organisational growth and service management.

On the other hand, there are certain support activities, which help the primary activities and they help in formulating a base for any organisation. These activities are explained briefly as follows:

This is related to the support activities within the firm, which enable it in maintaining its daily operations. For instance, the managers could obtain information regarding administrative handling, line management and financial management, as these factors formulate value for the organisation.

This is mainly associated with the workforce development within an organisation, as it is the significant element. For instance, staff recruitment, staff coaching and training along with staff compensation and retention involve some costs, which the managers need to understand for estimating cost.                                    

These activities are associated with product and service development of the organisation internally as well as externally. Some examples include information technology, creation of new products along with technological improvements and innovations depending on new technologies (Kaplan and Atkinson 2015). Hence, the managers could obtain the costs associated with these activities, as they create value through optimisation and innovation.

It includes support activities associated with procuring the customer services from the organisation. Some instances include entering into and handling supplier relationships, negotiating to settle best prices, forming agreements of product purchase with the suppliers as well as outsourcing agreements. Thus, by analysing the costs of these activities, the managers could utilise primary and support activities like building blocks for developing valuable products and distinctiveness (Rothaermel 2015).                            

4.With the help of value chain analysis, the physical depiction of the various processes of Adelaide Brighton Limited is facilitated, which is involved in manufacturing lime, cement and dry blended products. The value chain analysis of Adelaide Brighton Limited is discussed as follows:

These activities help in facilitating the arrangements for inbound transfer of lime, cement and dry blended products from the factories to the manufacturing units. The operations and functions of Adelaide Brighton Limited are focused on process administration that translates the raw material inputs into finished goods outputs (Adbri.com.au 2018).

This procedure includes raw material procurement from the factories to the manufacturing units, in which there are plant and equipment. The technological unit in combination with the manufacturing units is related to pertaining equipment like software, hardware as well as technical knowledge initiated by Adelaide Brighton Limited so that the inputs could be converted into finished products. The organisation is supported effectively by such activities like accounting and finance associated with controlling quality and public relations (Simatupang, Piboonrungroj and Williams 2017).

Conclusion:

From the above discussion, it is inherent that with the help of value chain analysis, it becomes possible for any business organisation to estimate costs accurately based on which it could gain competitive advantage. The benefit obtained by linking value chain in cost estimation is that cost minimisation strategies are kept consistent throughout the organisation. Finally, it has been analysed that Adelaide Brighton Cement is involved in using value chain analysis for appropriate arrangement and procurement of raw materials from factories to the manufacturing units.

References:

Adbri.com.au., 2018. [online] Available at: https://adbri.com.au/-/adbri/lib/pdfs/2016/reports/AR%202017%20-%20Annual%20Report%20complete.pdf [Accessed 10 Nov. 2018].

Chenhall, R.H. and Moers, F., 2015. The role of innovation in the evolution of management accounting and its integration into management control. Accounting, Organizations and Society, 47, pp.1-13.

Cooper, R., 2017. Supply chain development for the lean enterprise: interorganizational cost management. Routledge.

Cooper, R., 2017. Target costing and value engineering. Routledge.

Grant, R.M., 2016. Contemporary strategy analysis: Text and cases edition. John Wiley & Sons.

Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning.

Langfield-Smith, K., Smith, D., Andon, P., Hilton, R. and Thorne, H., 2017. Management accounting: Information for creating and managing value. McGraw-Hill Education Australia.

Malmi, T., 2016. Managerialist studies in management accounting: 1990–2014. Management Accounting Research, 31, pp.31-44.

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.

Nielsen, L.B., Mitchell, F. and Nørreklit, H., 2015, March. Management accounting and decision making: Two case studies of outsourcing. In Accounting Forum, 39(1), pp. 64-82.

Rothaermel, F.T., 2015. Strategic management. McGraw-Hill Education.

Simatupang, T.M., Piboonrungroj, P. and Williams, S.J., 2017. The emergence of value chain thinking. International Journal of Value Chain Management, 8(1), pp.40-57.