In this post, we’ll look into how, over the last few years business frameworks focused on finding value in a firm evolved from the value chain to Porter’s 5 Forces, to the Business Model Canvas. Each model provides a different angle or insight into the process through which firms are able to develop their unique value propositions.
As a business consultant, whenever I study a new organisation, one of the biggest hurdles to overcome is actually figuring out how a business can be visualised or to some extent, simplified. This is because many times businesses can be made more efficient if one understands where the organisation creates value, and where the organisation stacks up cost.
Sometimes the difference between the two is not easy to find, as it’s somewhat nuanced. However, there are plenty of business frameworks that help us in doing that. Over the last decades, however, these models have evolved, focusing on different types of processes or assets. Traditionally, one of the first attempts to break down organisational processes was the Value Chain. Later on, as new perspectives on value creation emerged we had Porter’s 5 forces, and finally, in the first years of the 2000s we had yet another paradigm-shifting change of perspective with the Business Model Canvas.
Which ones should a company use? Should there be any preferences? In this post, we’re going to look at these frameworks and see what makes each one a little special, and, in what ways business thinking has evolved in terms of identifying value creation within a firm.
In this post, we’re going to discuss the following points:
- The Value Chain model and how it identifies value creation processes in a firm.
- Porter’s 5 Forces model and how it focuses on identifying non-replicable company assets.
- The Business Model Canvas and its customer-centric approach to value creation.
1. The Value Chain model and how it identifies value creation processes in a firm.
The Value Chain model is in many ways one of the simplest ways of breaking down in-company processes. The most basic definition of a firm revolves around collecting inputs and producing outputs, and to some extent, the Value Chain is aligned with this very simple concept.
The Value Chain sees value creation as a summation of 4 different activities:
- Research and Development. This is the stage where a firm creates value by developing products and services. This is usually a very expensive “department” for a firm, but a necessary one. This is where a company develops or updates its products and services, making sure that the product portfolio of the organisation can maintain its competitive edge. The one challenge that this department meets is connected to timing. The faster the shelf-life, or industry obsolescence rate, the more pressure is put on this part of the value chain to keep creating new and innovative products. For innovation-driven companies, most of the value can be found right here. However, innovation can come in many forms, each heavily impacting the way an organisation creates value. Here’s an additional article if you’d like to read more about this.
- Production and Manufacturing. This is the stage where firms manufacture their products to meet market demands. Production is an interesting segment of the value chain, as firms usually – after having completed the R&D stage leveraging mostly internal resources – are now in a position to look for partner companies to produce their products at scale, or with a reasonable investment. The contractual side of production and manufacturing, especially when it entails the management of patents or copyrights, is particularly complex, and is often a determining element when firms expand abroad. We discuss this topic in further depth in an article focused on foreign market entry modes. If instead, you’d like to read up more about licensing contracts, this is the right article for you.
- Marketing and Communication. Undeniably, whenever we’re working with low-differentiated products, marketing adds a lot of value to our product, not because of it’s intrinsic characteristics, but because of the way a product is presented to the customer. Attaching to a product different types of intangible attributes helps a firm increase its retail price, simply because it is able to alter the customer’s perceived value. Having said this, however, marketing and communication are very costly endeavours, as firms will need to almost literally “shout” their unique value proposition to a lot of customers. Of course, social media and digital technologies can help reduce this cost, but unless we have a clear picture of who our customer is it will be very difficult to obtain a return on investment. Customers need to be identified according to a series of common traits, in order to cluster them in groups, or segments, which can help us better understand how to formulate our value proposition. This is a rich area of discussion, which is addressed in this article, specifically focused on the fashion industry.
- Sales and Distribution. Last but not least we have sales and distribution. This might look like the “last mile” of the value chain, but it’s actually the starting point of your relationship with customers. We need to bear in mind, that out of the 4 stages of the value chain, the sales and distribution stage is actually the one which is revenue-generating. Again, following a parallel with R&D and production, we can see that in these latter 2 blocks (also known as downstream functions) Marketing is usually developed in-house, while distribution, usually entails for partnerships and collaborations, especially when striving to reach extensive coverage or a target market. Distribution has additionally become increasingly important, as it allows companies to interact, on a personal level with its customers. In many segments, like in luxury, the opportunity to establish a human connection and to provide a “purchase experience” is so valuable that firms invest in creating a forward integration strategy, consisting in owning and directly managing the retail outlets where a firm’s products are sold. Human contact has, in many ways been one of the few remaining added values that brick and mortar stores have in comparison to digital distribution. Of course, with no intention of exhausting the topic, we suggest this additional resource on fashion distribution for those who want to delve in more depth into this topic.
Will a firm get its competitive advantage on each of the four stages of value creation? It’s unlikely. Most firms will be able to identify in which blocks they may have assets capable of setting the organisation aside from its competition. It might be its ability to develop new products, or its ability to efficiently and timely produce them, or finding the perfect fit between a customer segment and their market offer, or finally, gaining an edge by distributing them over large markets.
Whatever the advantage, however, some argue that this model is very focused on a firm’s internal capacities, but it disregards almost completely its competitors, as the value a firm creates can be much better assessed by benchmarking it with its competitions. In this sense, Porter’s 5 Forces is capable of providing a new perspective on the value creation process of a firm, by taking into account 5 forces of competitive pressure that a firm needs to take into account. This is going to be addressed in the next section of our post.
2. Porter’s 5 Forces model and how it focuses on identifying non-replicable company assets.
Porter’s 5 Forces is in a way a very versatile tool, which can be generally used to look for value in many circumstances: from company management to asset allocation in finance. Porter’s forces model draws a unique insight into value creation in a firm: unless firm’s assets are well protected it’s really hard to maintain a competitive advantage in your industry. This is because on a 24/7 schedule all of your networks is going to pressurise you into reducing your profit margins in order to maintain competitiveness. All in all, in fact, many see Porter’s 5 Forces model as a tool which is very useful at identifying the degree of profitability which can be expected by a firm in a particular industry. Profitability, in fact, gets pressurized by 5 separate forces which are listed below. A more in-depth explanation can be found in the short video at the top of this section.
- Industry’s Rivalry. Each industry has a different level of rivalry. The high-growth sectors of our economy are in fact capable of attracting a higher volume of players, as a growing sector provides more profit opportunities. An interesting way to compare the industry’s rivalry is by using the BCG Matrix, which splits firms (and their relative markets) into 4 groups: Cash cows, Dogs, Question Marks and Stars.
- Bargaining Power of Suppliers. As suppliers are not going to benefit from the price markup of retail distribution, they will try to make sure they are able to get a decent percentage of profit by increasing the cost of the inputs of production to the firm. As profit is revenue minus expenses, the profitability of a firm will be severely impacted because of the behaviour of those suppliers who don’t allow the rest of the downstream supply to go to market with a competitive price.
- Bargaining Power of Buyers. Buyers too, either in a B2B or B2C relationship will in fact try to take advantage of the many different purchase options available either through physical or digital distribution in the market. As a result, in order to attract, convert and retain clients firms will be pushed to approach the market by lowering their profit margin, in order to compete on price.
- The Threat of New Entrants. As markets prove profitable, new entrants will be prompted to enter the market. As new entrants arrive, the rivalry in the industry will be harsher, and in order to maintain its market share, firms will be likely to keep pricing low. Pricing is the one variable of the marketing mix (Product, Price, Place, Promotion) that can be changed most easily, and this will potentially create the premises for neck-to-neck competition on lowering cost, at the expense of profitability. If you’d like to look more into pricing strategy as a strategic tool to address competition, we have an article for you.
- The Threat of Substitutes. This is a threat consisting of defending a firm’s products by those companies that can find ways to provide better, more comprehensive solutions to the problems that our products solve. A popular example of this threat is represented by smartphones, which completely substituted the low-end camera market. Only those firms developing cameras for a higher, more professional segment of the market were able to survive. Understanding how our products are essentially “hired” by our customers to do a job for them, really helps us in understanding the dynamics of substitution and disruption. To look more into this topic, here an article that might help by focusing on the Jobs to Be Done Theory.
As discussed in this model, the value generated by a company will be such only if correctly shielded from the opportunistic behaviour of suppliers, buyers, new entrants and substitutes. In this sense, the protection of a firm’s intellectual assets, comprised of patents, copyrights, trademarks and so forth, should be regarded as an activity of primary importance. However, this model too, has its limitations, as it perceives customers, almost as a counterpart to the firm, as opposed to a co-creator of value. Value co-creation is an alternative angle on value creation, as it states that it’s the relationship which is being created by the firm with its customers that bears most value to the organisation. It’s on this line that new models like the Business Model Canvas have been able to focus much more on the role of the customer and the value it delivers by interacting with a firm. The customer-centric approach developed by the BMC will be addressed in the next section of our post.
3. The Business Model Canvas and it’s customer-centric approach to value creation.
Last but not least, let’s look into the Business Model Canvas, or BMC for short. This model has been a very popular model over the last few years. Aside from its innovative formulation, what makes it unique is that it suggests, very subtly that an entrepreneur need to fail many times before succeeding. According to the BMC, the only way real value can be created is by assessing what value can be drawn from a firm’s assets that actually transfers to its customers.
So, how does this latter model compare to the other two? The difference is only a matter of perspective, the Business Model Canvas is much more consumer-centred, as it starts from the fundamental assumption that the value you are delivering to the market is not the logical consequence of a linear process, like in the case of a manufacturing assembly line, nor something that draws from one specific business element, on the contrary, value is created through the unique relationship between all of the assets your company is able to draw together to create a unique way of conducting business and creating value.
Let’s have a look at how you can start breaking down your business model and identifying how your firm can deliver a unique value proposition to its customers.
Your first task is to start visualising your business and identifying 9 key aspects of its internal business logic.
- Value Proposition. This is the section where you write down the product or service your company is providing, and how it solves a problem for your customer, in a much better way than the existing market options. Ideally, your product, service or solution can’t be only marginally better than the competition but be able to have a lead to affirm itself in the market for the longest time frame possible.
- Customer Segments. Not every solution will work with everybody. This is why your value proposition and customer segments need to be aligned. This is because in reality, the product you will design will be ideal only for certain categories of customers. It is your responsibility to figure out which categories of customers are going to be the most interested in your product and make sure that that category will be profitable for your firm.
- Channels. Only once you have figured out the previous two steps you can go ahead and identify the best distribution channels for your firm. Each customer segment will have channel preferences, which will also depend upon the product you are selling. At this stage, however, we can see how, we are already creating a strategy based on a wide set of variables, which help us clarify what makes our product stand out.
- Customer Relationships. Another element of customer-centricity of the business model canvas is represented by the customer relationship block. We need to know what kind of relationship we’d like to entertain with our customers, is it long-term, is it short term? Are we going to try and achieve lifetime value? Will they need to be advised when making a purchase? Is out product complex? Should we make sure that the customer service is always above a luxury standard? These are important questions which impact our distribution strategy and the perceived value of our product, and again, we need to figure it out, potentially through some trial and error.
- Revenue Streams. How are we going to make money? What type of revenue model are we going to pursue? This block is where we need to figure out in what ways our company is going to generate inflows of cash. Is it from selling the products? Is it from providing additional services? Again the business model canvas allows us to figure this out, in a way that is aligned with the rest of our framework.
Now let’s move to the part of your business which instead occurs in cost, rather than directly generating revenue. The left part of the model is dedicated to blocks which represent all of those processes that entail for cost, rather than revenue.
- Key Activities. This block requires you to write down the activities that your firm is going to put together in order to create value for its customers. By connecting this block to the value proposition, you’ll be able to understand what activities really transfer into your customer’s experience and which don’t, helping you to stay lean.
- Key Resources. This block allows you to think about the types of resources, both human and financial, that your company will need to manage in order to perform its activities. Again connecting the dots you are going to clearly see who in your team really delivers value, and how much of your financial resources are spent in activities which really matters.
- Key Partners. No company is an island. As you develop your business you will create many relationships which will become long-term assets for your company. In this sense, it is useful to map what individuals, organisations and companies are actually assisting you in the creation of value. Based on your partners you may see ways to acquire resources more efficiently or create partnerships to better deliver your key activities.
- Cost Structure. In this last block, you will need to account for all of the cost-generating processes, so that you can compare this with all of the revenue-generating activities and understand if your organisation can be profitable.
You will have certainly realized that because of the interconnected nature of the business model canvas, changing one of the blocks might entail changing the rest as well. This is the great insight provided by this model as it shows that in business a clear and aligned vision is able to create value which is greater than the sum of its parts.
What makes this tool exceptional in our opinion is the fact that the business model canvas is able to account for mistakes. The point of using this tool is not to immediately fill in every box with definitive answers, but to use it as a blueprint to conduct market research and find out information to complete all of the sections of the model.
As you start to fill in the boxes of this model, you don’t have to know much about business. To some extent, it can be argued that the less you know, the better. The whole idea of this tool is that entrepreneurs should be wary of their instincts and experiment as much as possible until they find real-life evidence of what works in the real world.
So is this, the one you should use to find value in a firm? In many cases, the BMC is considered a very current framework, especially in the analysis of digital and tech companies. However, the point of this post was not to establish a winner, as much as to show some of the patterns that define the evolution of business through over the last few decades. After so much content being discussed, let’s try to wrap things up in the conclusions.
As we’ve seen in this post, value can be found in different places, either in a firm’s processes, or in its exclusive assets, or in the unique revenue model. All in all, rather than establishing a winner, it might be better to take into account the limits that business frameworks provide. If, on the one hand, they are capable to simplify businesses which are, in many respects incredibly complex entities, on the other, they often risk narrowing down or over-simplifying them. In this sense, our advice is always taken into account your own bias. For the sake of immediate grasp and understanding, value-generating activities or assets may be downplayed. No framework will ever be all-encompassing, and many of the concepts we swear by today may become completely surpassed tomorrow. This is why in business, we should try to keep an open mind when it comes to using too much of a theoretical framework. In this sense, our advice is to take a broader look at the evolution of business theories, as they are a representation of the evolution of real life. To some extent, academia simply holds up a mirror, but not one that accurately reflects each individual firm.
All in all, let’s focus on the direction or the evolution that business frameworks are taking, so that we may preempt change while remembering that theories are not there to solve any problem a firm can possibly experience, but just to help us identify relationships of causality, so that we may act upon them.
But where does one reflect on the value of business education? If this is something you’re interested in looking into, in this article we discuss whether you should go to school or start a business.