Saturday, 22 September 2007

Understanding how a company creates value and competitive advantage

Objective: To gain an understanding of how a company creates value and competitive advantage, so that the solutions defined by the Enterprise Architect (using TOGAF) achieve the most benefit for the organization.

Tool: Value-chain analysis

Topic: Business Architecture (TOGAF phase B)

The term Value Chain was coined by Michael Porter in his book "Competitive Advantage: Creating and Sustaining Superior Performance" (1985).

The purpose of any business is to create value for its customers at a level that is greater than the cost to produce that value. Michael Porter described this process of value creation as a chain, implying that value is not all created at one point, but is increased continuously along a series of inter-connected business processes or activities, known as value-chain functions. By collaborating, these functions create the products and services that deliver value into the marketplace and (hopefully) create a competitive advantage for the company.

Porter identified five (generic) primary activities that would be found in most types of company: inbound logistics, operations, outbound logistics, marketing/sales, and service. He also identified four secondary activities: procurement, technology development, HR and infrastructure services. This generic value-chain is useful but identifying, characterizing and understanding the value-chain functions and the process by which your organization creates value is one of the first things you, as the Enterprise Architect, must do ... and here's why ...

Some value-chain functions will be considered core competencies whereas some will simply support other business activities. Core competencies are the primary business activities that generate value for the company. They may or may not be the activities that product products and services. Enterprise Architects must make a strategic decision on the solution for each value-chain function. A decision to invest in a new solution for one business activity may be balanced by outsourcing or divestment of another business activity. Any roadmap of development or deployment should give a high priority to core competencies.

No modern business is an island. Value-chains are now inter-connected across divisions, subsidiaries, companies and even international borders. In fact, Porter described collaborating value-chains as a value system. These collaborative connections are crucial to the success of the overall value-chain and represent flows of information, goods and services, as well as systems and processes for adjusting activities. Enterprise Architects must make decisions over these connections or interfaces along the value-chain, the technologies they will use, the security they require and the information that must be exchanged to make the value-chain efficient.

Value-chain functions may also be shifted up or down in the value-chain, but may never be deleted. For example, in a value-chain comprising functions A – B – C – D, if B decided to work directly with D, then the result is simply A – Bc – D rather than A – B - D. C has been disintermediated from the value chain but that business activity must still be performed somewhere, although it may now be achieved in an entirely different way. Enterprise Architects must make a strategic decision over the changes they make to the value-chain. New technology and new business processes can have a significant impact on the value chain, potentially creating a far more effective business ... or chaos.

Companies that do not want to become victims of disintermediation must give themselves a comparative advantage over competitors; whether by being the lowest cost provider of that product or service, or by delivering something else considered important or valuable to its customers (e.g., superior service, an innovative process, a patented technology). New solutions must, therefore, raise barriers to entry against competitors and against potential disintermediation. To achieve this, Enterprise Architects must understand what comparative advantage they delivering with their solutions.

To learn about a technique I use to understand the influences, and the drivers of change, on a company, please click here.

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amichaels said...

The article above is an excellent review of Porter's concepts.

One additional comment is that most companies are made up of many businesses; and each business unit requires its own strategy. In companies with many businesses that have different strategies for a given activity or process (say, for online ordering) Group Executives should consider modifying some SBU strategies to align each of them with a common approach to make it easier for customers that order from multiple business units. However, many business units with differing goals and budgets just put in their IT requests, leaving Enterprise Architects to build a common platform based on different strategies – and leaving Enterprise Architects and the company stuck in middle.

Again, great article.

Alan S. Michaels

TechnoMorph said...

You make an excellent point Alan.

The growth in global trade is principally between subsidiaries of multi-national corporations (MNC).

Business units of the same organization may focus on functions in the value system that co-operate to deliver the same product, or may perform the same value-chain function (like manufacturing) but deliver a different product or service.

These functions are inter-dependent if the organization is vertically aligned (e.g., the subsidiaries perform different but related functions of an energy company). They are co-dependent if the organization is horizontally aligned (e.g., the subsidiaries provide different services to the marketplace).

Enterprise Architects must provide solutions for each business unit but should also take a holistic view of the entire enterprise, to identify opportunities to achieve economies of scale or more efficient means of production.