Value-chain analysis exploiting internal linkages

Value-chain analysis is identifying and exploiting internal and external linkages with the objective of strengthening a firm’s strategic position. The exploitation of linkages relies on analyzing how costs and other nonfinancial factors vary as different bundles of activities are considered. For example, organizations change their structure and processes as needed to meet new challenges and take advantage of new opportunities. This may include new approaches to differentiation. Additionally, managing organizational and operational cost drivers to create long-term cost reduction outcomes is an important input in value-chain analysis when cost leadership is emphasized. The objective, of course, is to control cost drivers better than competitors can (thus creating a competitive advantage).

Exploiting Internal Linkages
Sound strategic cost management mandates the consideration of that portion of the value chain in which a firm participates (called the internal value chain). Exhibit 11-5 reviews the internal value-chain activities for an organization. Activities before and after production must be identified and their linkages recognized and exploited. Exploiting

internal linkages means that relationships between activities are assessed and used to reduce costs and increase value. For example, product design and development activities occur before production and are linked to production activities. The way the product is designed affects the costs of production. How production costs are affected requires a knowledge of cost drivers. Thus, knowing the cost drivers of activities is crucial for understanding and exploiting linkages. If design engineers know that the number of parts is a cost driver for various production activities (material usage, direct labor usage, assembly, inspection, materials handling, and purchasing are examples of activities where costs could be affected by number of parts), then redesigning the product so that it has standard parts, multiple sources, short lead times, and high quality can significantly reduce the overall cost of the product. The design activity is also linked to the service activity in the firm’s value chain. By producing a product with fewer parts, there is less likelihood of product failure and, thus, less cost associated with warranty agreements (an important customer service). Furthermore, the cost of repairing products under warranty should also decrease because fewer parts usually means simpler repair procedures.

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