Creating a value chain is as simple as understanding your customer and suppliers. You can build a value chain a link at a time if you know your customers and suppliers. If you have never created a value chain analysis before, a simple way to get started is to use these questions:
Who is my customer? (does my customer have a customer)
Who are my suppliers? (does my supplier have a supplier)
Have I reached the start or end of the value chain?
What is a value chain analysis?
A value chain analysis is a great tool to understand better the flow of value and cash in an industry. A value chain maps the flow of goods or services (value) from left to right. In the reverse direction (from right to left), the value chain maps the money flow and margin (cash). The value chain mapping also provides a great perspective on how your startup fits the overall industry.
the importance of doing a value chain analysis
A value chain is an essential tool in mapping the flow of value created in an industry. Once you understand the value flow, you can create a map of the industry’s money and margin. Then, you can use the analysis to determine the best place to mine value in the industry. A value chain is also helpful because it will show you where your startup fits the overall industry. Understanding where your startup fits in the industry can give you insights and ideas into developing a solid launch strategy.
Mapping the value chain
You can use a linear search technique to map stakeholders from the supply source to the end-user to create a value chain. The exercise may seem overwhelming at first, but don’t be deterred. The activity is simply identifying customers and suppliers in the chain. The best place to start is with your startup. Ask yourself who are my customer and who are my suppliers. Here is a shortlist of the three steps to create a value chain analysis:
Find the beginning and end of the value chain
Map the flow of value and money within the chain
Conduct a financial analysis of the value chain
Finding the beginning and end of your value chain
If you want to map a value chain, you need to find the beginning and end of the chain. Keep in mind that value flows from left to right, and cash flows from right to left. The supply source is the furthest left stakeholder, and the end-user (customer) is the furthest right. I like to use a simple linear search technique. First, I start from my company and go to the right to find my customer’s customer until I reach the end-user. Secondly, I go from my startup to the left to find my suppliers’ suppliers until I come to the supply source. It is that simple.
Finding the end-user – In my opinion, the best place to start when mapping the beginning and end of a value chain is with your startup. To find the end-user, you need to identify the customer of your customer and the customer of their customer, yada yada yada, until you get to the end-user. While this sounds simple, and it is, you need to have your detective hat on and be carefully searching for clues while being prepared for surprises.
Finding the supply source – Once you have found the ultimate end user, the next step is to find the supply source. In this case, you are following your supply chain by asking who my suppliers are and do my supplier have a supplier. Keep asking the question, rinse and repeat until you reach the supply source.
Mapping the flow of value and cash
When doing value and cash flows, you want to map the transactions between links in the value chain. There is always a transaction from each stakeholder link of value to cash. The intent of modeling the transactions between stakeholder links is to understand these transactions better and determine where the value is.
Value flows from left to right – and can be either a product, service, or another type of intellectual or digital property. For each stakeholder link in the value chain, you will want to understand the transaction. Furthermore, it is vital to know the true value of both sides of the transaction. Thus, you will need to do some digging to find the fundamental value proposition.
Cash flows from right to left – I try to understand and model the revenue related to the transaction. For example, is this a subscription (like SaaS), a one-time purchase (like a big-ticket item fridge or stove), or another type of transaction?
The better you can model the transactions between stakeholders, the better you understand the flow of value and cash. In my opinion, understanding the transaction dynamics of a value chain is one of the most important aspects of developing a sustainable business model.
Financial Analysis
You have mapped the value chain from beginning to end. You have identified and included stakeholders from the supply source to end-user and back again. You have also modeled the value for cash transactions between all stakeholders. Now you are ready to take a deep dive into the financials of each stakeholder transaction.
I start my financial analysis by identifying which two (2) or six (6) digital NAICS code is associated with each stakeholder in the value chain. I do this because if you know the NAICs code for the stakeholder, there is aggregated information available from Statistics Canada and US Census Bureau on financials by NAICS code. I will also check my competitor’s news and press releases for clues into their financials. Then, armed with as much information as I can find, I start to model the financials of each stakeholder in the chain. The purpose of this analysis is to understand where the margin is in the industry. If you know where the margin is, you can plan your strategy accordingly.
My experience has taught me that the best place to find value chain information is through secondary research. Usually, the first place I start to look is at my direct competitors. In theory, both the customer and supplier of my competitor are potentially my customer and supplier. If you can identify some US publicly traded companies that are either your customer or supplier, SEC 10k reports are a great source of information. Please check out this post on competitive analysis for more details.
Conclusion
In my opinion, a value chain analysis is an essential tool to help gain a better understanding of your target industry. I use value chain analysis whenever I investigate a new market. Understanding the value chain will provide a great visual of your industry’s value and cash flow. You can make pragmatic decisions regarding product launches and potential partnership opportunities when you know industry-wide cash flow.
Cheers,
Ian Paul Graham