CHAPTER 7

Value-chain analysis and

accounting

Key learning objectives

After reading this chapter you should be able to

explain the concept value-chain analysis;

describe differences between value-added analysis and value-chain analysis;
demonstrate an understanding of how Porter's value-chain framework can
be applied to the business for excellence:
outline the strategic cost clasifications in the value-chain framework:
describe the differences between the corporate value chain and an
individual products value chain:
demonstrate an understanding of how management accounting systems
play a vital role in value-chain analysis;
understand the application of a value-chain framework in a manutacturing
setting.

VALUE-CHAIN ANALYSIS AND ACCOUNTING 107

 Introduction time; time; unnecessary process steps;
eaCtivities: preparatiorn waiting
As companies enter a new millennum, they should remain commitcd t rhe o
times; transportation/distribution; process
catoduction; rejects, set-up
cnhancing their long term comptitiveness by providing high quality produ communications; administration/decision-making:
ste; terials
materi
waste;
and services at a reasonable, compctitive pre. lo achicve this aim, companie
nes
timing (Morgan and Murgatroyd, 1994).
bottlenecks; and
on understanding the total value of all
Value-chain analysis places emphasis
uni

nced to analyse their cost structure and identity strategies for buildine llong
.
value
term growth. Managing costs and monitoring ctectiveness requires a bro the business, as well as the industry. By considering the
broad
perations across

Can determine areas

where cost can be minimised (for cost-
focus that NMichacl Porter calls the 'value chan. A good way to achieve this aim
hain organisations, where customer value can be enhanced (for
is to ascertain where a firm's products are located in the value chain. Value-cha Ldership strategy)
and areas

business focuses the

analysis is a method for decomposing the firm into strategically importa strategy). T he value chain ofa on

roduct differentiation materials from

activities that range from the receipt of raw
activities and understanding their impact on cost behaviour and differentiation,
cet of value-creating
research and development products and processes, to the sale
ot
the generic strategies proposed by Porter. How management accounting tools cuDoliers and
can be usefully accommodated within the value-chain concept has received to the customer and the provision of after-sales customer
of the product that
limited artention. This chapter looks at this contemporary issuc. Customer value reters to the characteristics of a product or service
nDott.
as valuable.
customer perceives
a

Value-chain concept: what is it and what does it offer?

framework: applying it to the
A value chain describes the linked set of value-creating functions that are
Porter's value-chain
business for excellence
required to bring a product or service to the customer. It begins with basic raw the value chain of the
materials from suppliers, moving to a series of value-added activities involved in Porter proposes to extend value-chain analysis beyond
well the value
producing and marketing a product or service and ending with distributors with and customers, as as
business to consider a linkage suppliers
getting the final products or services into the hands of the ultimate customes. chains of competitors.
Michael Porter (1980, 1985) has developed this value-chain concept as a toal Porter proposes that a tirms value chain is composed ot nine categories of
to help businesses analyse their cost structures and identify competitive interrelated activities. These activities are, in part, primary activities and, in part,
facilitate the former.
strategies. support activities. The latter exist to

that costs occur, merely in

A value-chain analysis emphasises not

It useful perspective for

manufacturing, but the
across business. provides a Primary activities
and
understanding non-manufacturing cost classifications. Supplying Primary activities include:
manufacturing activities are described as 'upstream segments of a value chain,
value nbound logistics activities involve managing inbound items such as raw
while marketing and distribution activities are 'downstream' segments of a
chain. materials handling and warehous1ng.
Operations activities involve the transformation of inbound items into
Value-added analysis and value-chain analysis: how do products suitable for resale, for example research and development. product
design and manufacturing.
they differ?
Value-added analysis involves classifying activities as valuc-added or non-value 'Outboundlogistics activities involve carrying the product from the point of
added. This concept is adopted to identify which activities to keep and whict manufacturing to the buyer such warehousing and distribution.
as

add value to
to eliminate. The following activities in organisations tend not to

108 STRATEGI MANAGEMENT AccoUNTIN AUE-CHAIN ANAL YS/S AND ACCOUNTING 109
 Marketing and sales activitics involve informing buycrs about products an
and potential sources of
services with a reason to purchase, stich as distribution strategy behaviour of costs, and the existing
and nderstand the performing these
firm gains competitive advantage by
promotional activitics, including advertising.
A
Aiferentiation.
orbetter than its competitors.'
morecheaply
aCtivities One of
Service includes all activities requird to keep the product or servi has several distinctive characteristics.
5crvice Porter's value-chain analysis on the complex linkages
and
working effectively for the buyer,
after it is solkd and delivered. Examples of of value-chain analysis insists
hese attributes business unit and its customers
such activities include installation, repair, alter-sales service, wartan both between the strategic
ranty interrelationships
tound internally. If these linkages are exploited,
a
claims and answering customer inquiries. as well as
those
and suppliers This necessitates

frm is
more likely to gain a competitive advantage.
not only at the activities
internal to the
to refocus, looking
management having firm. This in turn highlights
Support activities activities external to the
at those
frm, but also and end-customers, which in
In support of the above primary activities of the value chain, Porter propos firm to work with suppliers
oDportunities for
the
Value-chain analysis also
four support activities: (1) procurement (purchasing), (2) human resour lead to increased competitive advantage.
r n should
turn firm interdependent rather than
activities internal to the
are
management (HRM). (3) tcchnology development (R&cD) and (4) the fumi
recognises that to implementing its
infrastructure (accounting, finance, strategic planning, etc.). These activitie firm's history, its strategy, its approach
independent. A reflected in the Porter
of its situation are
feed into each stage of the primary activities. the underlying economics
strategy and
value-chain framework.
Markets develop and evolve in response to changing customer expectations
and the continuous improvement of offerings by the organisation and its
competitors. It becomes necessary to look constantly for newer, more effective chain: what is it and how does it differ
ways of targeting or changing the organisations ofterings, formally done by Corporate value
product's value chain?
implementing a strategic plan. Before setting the strategic plarn, the corporae from an individual
value activities lead to a better
capabilities, market opportunities and threats and the key success factors in the individual can
The systematic exanmination ot
and weaknesses. Porter (1985, p. 36)
industry, all need to be identified. The business is then able to set reasonable understanding of a corporation's strengths
objectives for itself, for example to be a market leader o r to increase market suggests that
differences among competitor value chains are a key
source
of
the following
share by a certain percentage. As discussed in Chapter 2, Porter sees competitive competitive advantage. Wheelen and Hunger (1998) propose
created in main ways through cost leadership or steps in a corporate value-chain analysis:
advantage as being two -

differentiation. chain and consider its strengths and

As discussed in Chapter 2, Porter has identified five forces that can afect
Examine each product line's value
weaknesses.
the profitability of the firm: (1) the threat of new entrants; (2) the threat of
substitute products and services; (3) the rivalry among existing organisatio Examine the 'linkage within each product line's value chain. Linkages are
within the industry; (4) the bargaining power of suppliers; and (6) the connections between the way one value-added activity (e.g. marketing) is
bargaining power of consumers. He puts all these concepts into a framework, performed and the cost of performance of another activity (e-g quality
which he labels as the value chain. Porter suggests that the initial step for a firms
control).
strategic analysis is to define its value chain. It is suggested that competite
ot ditterent
advantage, irrespective of whether the firm adopts a cost leader or difterentl
Examine the potential synergies among the value chains
product business units. Each value element (eg. advertising or
lines or
strategy, be achieved in the value for money, that B
marketplace by giving manufacturing) has an inherent economy of scale in which activities are
competitive advantage comes from carrying out the value-creating activitie
conducted at the lowest possible cost per unit of output (ie. sharing
more cost-cffectively than one's competitors. According to Porter, "The value
resources by two separate products in the corporate value chain).
chain desegregates a firm into its strategically relevant activities in order

110 STRATEGIC MANAGEMENT ACCOUNTING VALUE-CHAIN ANALYSIS AND ACCOUNTING 111

 A case study of the Porter value-chain
framework of increasing
of increasing sales and market share. The
emphasis on
quality
Alpha is a subsidiary of large New Zcaland multinational
a the
strategy
ISO 9000 certitication and total quality management (TQM) practices
produces and markets plastic packaging for cgSS. ice creamcorporation.
through 1 S o
Alpha ositive influence on profitabiliry. The ability of the mpany's
and pet food and been a positi
other disposable packaging. Alpha has tour main has al staff to form liaisons with the customer's markets is seen as one of the
functional departmente technical

accounting, sales and marketing. manutacturing and technical. factors ot the company.
The success
key The Alpha
manufacturing department has four divisions: human resources, quality strategy:

purchasing and process engineering. The tinancial accountant, sales and To build a long-term profitable furure for Alpha Food Packaging employees and
marketing manager and technical manager form the company's value supplier of packaging solutions
team
responsible for strategic decision-making.
management stakeholders striving
by to be the highest
international markets.
domestic and
to
Alpha operates in an intensely competitive environment.
intense due to the limited number of customers. Competition is danted a differential value-chain strategy to improve its competitive
Alpha concentrates on selling
to the major manufacturers ot The company continuou searches for market opportunities and
margarine, Ice cream and butter products in New advantage.
Zealand which are able to purchase goods in large experiments with possible new trends and product innovations.
quantities. The main priority regularly
in the value-chain of the plastic
Figure 7,1
of Alphas target customers is to receive
quality packaging delivered on time, illustrates Alphas overall position
Sinceprice is not their customers primary concern, Alpha is able to charge food-packaging industry. Oil refiners, plastiC granule manufacturers and die
a
raw materials. Alpha has rwo different
premium. According to the chiet executive, "The source of the
company's nanufacturers supply basic groups of
usTOmers: food companies and distributors/ retailers. Alphas strategy focuses
competitive advantage is the hygienic and clean manufacturing conditions the
on producing products of high quality. In order to achieve this strategic goal,
company has and production method not yet used by any other New Zealand
a

competitors.' rhe company attempts to be creators of change by working on product

Australian manufacturers are
constantly approaching Alpha's customers innovation. The company's regular experi:nents with product innovation are
seeking new business. At the time of the study, the favourable New Zealand founded on the basic question: What do:s the customer want?' This helps
exchange rate allowed the company keep its existing customers, although
to Alpha identify ways to exploit linkages with both their suppliers and customers.
and to enhance differentiation.
Australian plastic food-packaging companies were constant threat. Risk and
a

uncertainty are prevalent throughout the organisation's environment. The chief To achieve competitive advantage, Alpha also introduced partnership plas

executive reports that a number of New Zealand food producers are currently
considering building megasites in Australia. These proposed plants would be
large enough to cater to the whole Australasian market. Goods would be
manufactured and packaged in Australia and then supplied to New Zealand. If
this becomes a trend, Alpha would need to make some major strategic decisions
concerning its operations.
The main risk the company faces is in the manutacturing environment
There is a constant danger that large technologically-driven multinational
with its customers in late 1993. Alpha works with its customer groups to better
understand their needs and to negotiate their customer requirements.
Customers are invited to visit the factory site to examine the production
process. Technical and design staff advise customers on various aspects of the
production process. Alpha management believes that such 'partnership with
CUstomers' policy helps the company to lock customers into the business.
Management at Alpha places emphasis on continuous improvement
PrOgrammess and TQM principles across the organisation. Alpha's abiliry to

organisations with immense resources in the field will develop a berer

plastics
and cheaper end-user product than is currently available from Alpha.
Alpha's sales and profitability have been steadily increasing with a growth
in sales of 37 per cent over the last three years. At the time of the study, the
E nd pre-empt customer needs enables it to focus, not only on the activities
to the but also on those activities that are external to the firm.
rnal firm,
his highlights opportunities for the firm to work with suppliers and end-
e r s , which in turn leads to increased competitive advantage. Alpha

company's gross turnover was $30 million. The company places emphasis on Ces competitive advantage by understanding (1) the linkage berween
Ppliers' value chains and the the linkage
company value chain and (2)

STRATEGIC MANAGEMENT ACCOUNTING

112 1LUE-CHAIN ANALYSIS 113
AND ACCOUNTING
 team
Strategic planning
and decision-making
Oil
and M
Gencral management, finance & accounting
Firm quality management
A
Oil refincrs intrastructure

skilled workforce, qualificd & R

Alpha's Recruiting
education and training,
professional personnel,
Human

suppliers resource
Pr e w a r d s , recognition, ctc.
G
Plastic granule management

Alpha's competitors manutacturing

CAD/CAM, flexible manutacturing systems
Technological N
development

Converting operations Dye

Company A and manutacturers Limited & quality suppliers, high-tech
machines,

company B latest computer technology

Procurement
M
(Australian firms)
Plastic containers/ Alpha company .CAD/CAM Partnership CompetitiveProduct
packages manutacturers case studyfirm) Reduced plans with pricing ajusUna
Company C level of high-tech
inventory Quality customers
hannel Training R
(Swedish subsidiary packaging Quality relations Service
company) and Quality Capaciry products Sales torce repairs
Food companies suppliers
Company D (New utilisation On-time Promotion
(dairy, pet food) .Effective delivery through
Zealand company) material Fine tuning
Alpha's handling and testing customer

customers visits
Parts,
picking&x
Distribution/retailing delivery
Outbound Marketing & Sevice
Inbound Operations
logistics sales
logistics
End-use customers Source: Hoque (2001).

Figure 7.2 Value-chain elements of Alpha Packaging Company.

Figure 7.l Alpha's value chain framework.

value-chain
berween the buyers' value chains and the company value chain. In general, most Management accounting systems in the
managers believe that such an exercise provides opportunities for the firm to framework
increase its profitability. When organisational philosophies move to an external orientation involving
7.2. These
The value-adding activities at Alpha are summarised in Figure Customer gain a competitive advantage, accounting
satistaction in order to
too
choice
activities are managed and organised in line with the company's strategic oriented. Iraditional
continuous
needs to
change its focus and become more strategically
and business-like principles, such as c u s t o m e r focus and internal tocus
anagement accounting systems have been criticised for a greatet
improvement, change in management/organisational culture
and partnerships is, the value
Within which a
key theme is to maximise the difterence (that
With customers and suppliers.
uded) between purchases and sales. There is the view that
traditional

intormation on non-tinancial
dagement accounting does not give adequate
external factors crucial to the long-term survival of the firm. The challenge,

STRATEGIC MANAGEMENT ACCOUNTING

114 115
VALUE-CHAIN ANALYSIS AND ACCOUNTING
 thereforc, involvesmanagenment accounting moving away from
'managerial cost analysis' to a forward thinking 'strategic cost tradition
a
capacity utilisation;

analysis
'strategic management accounting (Shank and Govindarajan, 1992a, plant layout efficiency;
1993: Hoque, 2001). 19921
According to Porter (1985), a valuc-chain cost
managemcnt methodolo.
. product configuration;

involves the following steps: og

and customers.
linkage with supplierS
Identify the value chain, then assign costs, revenues and assets to vl
value ofcosting the value chain has caught the attention of many
activities. The
process

management
ccounting researche Shank and Govindarajan's (1988) study of
shows that a change from a traditional
Diagnose the cost drivers regulating each activity. Baldwin Bicycle Company
the
counting system (such as standard costing) to one that better fits with the
Develop sustainable competitive advantage, either through controlling co organisation's:strategy can be advantageous. Costs are assigned to each value
drivers better than
competitors, by reconfiguring the value chain. comprising the chain in an organisation and cost drivers are identified
or
rivity
final step is build sustainable competitive advantage
Within the value-chain framework, costs are classified into Ge each activity. The to a

structural and the cost drivers to reduce by rearranging the value

costs or
executional. Structural cost drivers derive from a company's choices irher operating on

about its those activities in which the firm has a competitive

underlying economic structure. These choices drive cost positions for any given hain, focusing on

product group. There are at least five strategic choices that a firm must make
advan tage.
Accounting in the value chain covers more than the conventional concept
about its underlying economic structure:
with both suppliers and
of value added which ignores important linkages
1. Scale - the size of the investment in qustomers by focusing only on value added within he firm. From a strategic
manutacturing, R&D and
marketing
resources. aDproach value added has problems because it starts too late and finishes too
soon. Starting cost analysis with purchases misses all the opportunities for
2. Scope- the degree of vertical integration. raking advantage of the firm's suppliers. That is, firms need to develop good
relations with suppliers and investigate how costs can be reduced for both the
3. Experience how many items in the past has the firm
already created and
what is itdoing again?
firm and its suppliers, e-gthrough ordering, freight and qualiry
Porter's value-chain analysis provides the better basis for strategic
4. Technology- what process technologies are management accounting design. For example, Shank and Govindarajan (1988)
used in each step ofthe firms suggest that life-cycle costing relies on value-chain analysis as explicit attention
value chain?
to post-purchase costs by the customer can lead to more effective market
5. Complexiy- how wide a line of products or services is being offered to segmentation and product positioning. Similarly, JIT relies on value-chain
customers? analysis as it considers supplier relationships.
In light of Porter's value-chain framework. Shank and Govindarajan
Executional cost drivers are the determinants of a firmis cost position that
hinges on its ability to 'execute them successfully. These cost drivers may 992a) suggest that a strategic-focused management accounting is rcquired to
include: provide managers with information to support decisions relating to each
activity and process of an organisation. Others suggest that management
workforce involvement; cONunting information can assist managers in: establishing new competitive

total quality management;

Cges evaluating existing competitive strategies; and monitoring and
4ssessing progress towards particular strategies.

116 STRATEGIC MANAGEMENT ACCOUNTING

LUE-CHAIN ANALYSIS AND 117
ACcOUNTING
 Strategic managenment accounting ntetatire Suggests that companies
Strategy and adm1inistration
choosing a cost leadership strategy woula put heavy cmphasis on conventional
al
costing and control systems, such as standard costing and variance reporting.
structural cost driver analys1s (g. scalc, scope, cxpetience, technology and
firms
complexity) and flexible budgeting. Conversely, pursuing a differentiation Production Marketing Distribution
non-conventional intormation and control systen.
Research & Design
strategy largely focus upon devclopment
such as exccutional cost driver analysis (e.g. workforce involvement, TOM
with suppliers
capacity utilisation, product contiguration, linkage or

customers), marketing cost analys1s and non-financial pertormance measutee

There is the view that strategic management accournting moves from structural
drivers to cxecutional drivers because the insights from analyses based on
Strategic management accounting
structural drivers are too otten obsolete and hence ineffective. (Activity-based costing; strategic
cost analysis;

As the value-chain concept is radical and no longer uses many conventional balanced scorecard; benchmarking)

measures of achievement such as contribution margin analysis, strategic

management accounting needs to be adopted. Management accountants will 7.3 The value-chain framework and strateg1c management accounting.
need to identify appropriate cost drivers and activities which are able to provide Figure

information about what activities are performed, why they are performed and between an organisations value-chain
shows the relationship
Figure 7.3
how well they are performed. This suggests a system-wide, integrated approach The figure shows that the
accounting systems.
- activiry-based management - that focuses managements attention on all framework and management (usefulness) is
ot bus1ness tunctions in which utility
activities of the organisation and maps the complete length of processes value chain is the sequence It also shows a strategy and
o r services of an organisation.
added to the products
(Hansen and Mowen, 1997). Thus through activiry-based management which spans all individual functions. This category
administration function,
accurate cost and performance information can be routinely used as the basis with the overall responsibility for the
for decision-making, thereby enabling a firm to be better able to identify includes senior executives charged
organisation.
opportunities for improvements and to understand the relationships between Strategic management accounting is a major
means of helping managers (a)

drivers and resources/activities volume and performance measures. The of the business functions presented in Figure 7.3 and (b) to
to administer each
immediate advantage of value-chain analysis will be the result of the process as a whole.
coordinate their activities within the framework of the organisation
itse!f as well as the enhanced quantitative awareness of the external competitive
arena and the firms part in it.
Simmonds (1981) suggests that strategic management accounting can Chapter summary
enable a firm to study competitors' pricing, costs, strategies and volume, which Value-chain is a way of breaking down a firms strategically relevant
analysis
is essential to assess its position relative to its competitors. Management actuvities in order to understand the behaviour of costs. According to Porter,
understand that each component is interdependent in each more cost-
accountants must
competitive advantage comes trom carrying out these activities
value chain in order to analyse whether or not an activity is value-added. The etectively than one's competitors. Any enterprise seeking a sustainable
to assess the
suggestion is for the greater use of non-financial measures in order competitive advantage must select a generic strategy rather than attempting to
firm's strategic initiatives (Hoque, 2000b). Recently, researchers have
advocated
be 'all things to all people' or 'stuck in the middle.
that
for an
integrated' or "balanced' performance measurement system In recent yeats, traditional management accounting has been criticised by
combines both financial and non-financial measures of performance (Kaplan for its inability to provide adequate information tor strategic
everal academics
and Norton, 1996; Hoque and James, 2000). the cost of
planning purposes. Few conventional MASs go beyond spotlighting

118 STRATEGIc MANAGEMENT ACCOUNTING VALUE-CHAIN ANAL YSTS 119

AND ACCOUNTING
 production within firms and to monitor these internal costs relative to plas
between the value-chain framework and the
Information traditionally supplied to senior executives limits them to a narto Describe the relationship
rtow 7.6
view of the business. It does not give sufticient information on non-financid MAS
and external factors crucial to strategic planning and control. Tradition the difterences between structural cost drivers and executional
ona Compare
management accounting cannot be an appropriate vehicle for assessino 7.7 cost drivers.
the
economic value of a given strategy or for choosing between competin. with using traditional accounting methods in the
What are the problems
strategies. Strategic management accounting, on the other hand, has the abil 7.8 how strategic management accounting can
value added chain? Explain
to provide accounting information to guide decisions in the strategic arena, i overcomethese problems.
be used to
strategic objectives cannot be monitored and controlled through the accountin
system, the overall impact of the decision will not be known until after it h
ting If a company
has cost leadership as its strategy, how can accountingg
79
7.9 contribute to meeting this goal?
been implemented.
for the value-chain
10 Why is strategic management accounting necessary
to be successful?
Key terms to learn concept

Explain the relationship betw

en the value chain, strategic planning and
7.11
Corporate value-chain Strategic cost classifications decision-making. Give examples.

Management accounting systems Value-added analysis

Porter's value-chain framework Value chain
Further reading
the emperors new

Discussion questions Lord, B. (1996) Strategic management accounting:

clothes', Management Accounting Research, vol. 7, pp. 347-66.
7.1 Explain the value chain concept. How can the value chain help
Parridge, M. and Perren, L. (1994) 'Cost analysis of the value-chain: another
businesses?
role for strategic management accounting, Management Accounting (UK),
7.2 Categorise the following processes as value adding or non-value adding Pp. 22-6.

transportation/distribution;
materials waste;
rework;
quality inspection;
set-up;
assembly;
painting
7.3 What is the difference berween primary activities and support activities
in the value chain?

7.4 What are the steps in a

corporate value chain analysis?
7.5 What are the differences berween the corporate and an individual
product's value chain?

120 STRATEGIC MANAGEMENT ACCOUNTING

LUE-CHAIN ANALYSIS AND ACCOUNTING 121