Defining the Value Chain
Note: We recommend you read this post on value before continuing!
Now that we have established a formal definition of value, this post will cover how to put it into a realistic business context. The value formula (value=benefits-cost) makes it easy to understand at a high level where and how value is being created. Value also gives the company overarching vision. Despite this, the high level vantage point isn’t very useful for further process analysis or controls, given the many exchanges or steps needed to get to the final product.
Often, the customer only pays for the total value of all the value-adding steps in a process; however, because there are multiple steps in the process which add incremental value, those steps are collectively referred to as the “value chain”. In other words, if there is a process, there is value being exchanged, and if that process has multiple steps, there is a value chain. Each step in the sequence can then be deconstructed for analysis.
It is always advantageous for companies to break down these interactions within a value chain so that they can understand where they may be experiencing shifts in demand or market conditions that are weakening their value creation overall. Understanding the chain of value creation is the target of the Cavi Method analysis phase. Once the value chain is derived from a given process, it is like understanding the DNA of that process. With the DNA exposed, assessing and controlling what is going on at the workflow layer becomes possible.
For the purposes of this post, we will use the example of a company that builds wooden sailboats for customers. The company gathers raw wood, raw wool, and metal ore, and then executes a long process to eventually turn these resources into a boat that customers can take on the water. At the level discussed in the last post, it could be said that the customer views being able to move around on the water (specifically in a boat) as a benefit and will exchange money with the company for that boat – as long as their cost doesn’t exceed the perceived worth of the benefit. However, if the boat-making company started losing customers, we would want to understand why that is. This question would be difficult to answer if the only value consideration was “people want boats to move around on water.”
Oftentimes, the value that customers are buying is not simply the end result, but the sum of those incremental value additions that lower their overall cost or energy to receive that result when compared with alternative methods (such as building a boat themselves in this case). Even if the customer doesn’t consciously realize that they want these incremental value additions, they will react intuitively if any part of the incremental value creation becomes negative.
In building a more accurate picture of value creation, the first place to look is the workflow layer. Examine why every work step is done, and try to figure out at that level what the value exchange could be (if it were to be exchanged at that moment).
For example, if gathering wood means going into the forest and chopping it down to start the process, ask why this is being done. For the company, this is to get the wood to start building. Fundamentally, there is no other way to source wood. Is there value created in doing this? Maybe. The company in this case has invested in tools, time, experience, land/property, etc. that makes the work less expensive compared to an average person attempting the same activity. If that is the case, it could be asked at this very first step, would the customer be willing to pay for this to be done? Assuming the answer is yes, because manually gathering wood for an individual in the market is more difficult than it is for the company, value has already been created. To validate that, the company should theoretically be able to find customers that are willing to pay for harvested lumber. With this logic, a value unit has been identified, and the value chain is started.
Following the same logic, the value chain for boat building will have many value adding steps, such as shearing wool to make cloth, or mining ore for smelting into metal. The point is, if you’re trying to figure out whether something belongs in the value chain, ask yourself whether it could be packaged, and a customer would be willing to pay for it without additional process steps. Even though in this example the company’s customers are looking for transportation on water, they are actually buying many different value units in the exchange. By separating all value-adding from non-value adding steps in a process design, what is left is–by definition–the value chain.
Boat Building: Two Perspectives on Value
Because the value chain only describes value creation, it is theoretical and only for the purpose of analysis. It can never be enabled in the workflow layer in a 1:1 fashion because of physical constraints. For example, customers don’t pay for value when the company incurs costs moving staff around in their factory to get the work done (motion waste); however, until teleportation is invented, this is unavoidable due to physical constraints.
People sometimes confuse the value chain for the supply chain; however they are not the same. The supply chain is a description of the workflow layer activities that are needed to get an end product through all the suppliers to the end customer, waste included. A value chain for a particular supply chain will only describe the steps that create value within the process. In reality, most processes have many steps that yield no value, which is why the analysis of process design layer often categorizes steps into three types: value adding, non-value adding, and non-value adding but business required (e.g. wasteful activities that must be performed for regulatory or compliance reasons external to the company), in order to fully understand the entire cost structure of a given process. If costs in a single part of the value chain increase over time (because of non-value adding waste accumulation, for example), it could reduce value enough overall that the original value proposition is no longer viable.
Because of the importance of the value chain as a foundation for strong process design, the focus of the Cavi method is to derive the value chain by studying the process, and honing in on problems that form naturally in a single part of the chain. In a large company, there are often multiple processes and many value chains. To start applying the Cavi method, the first question to ask is “which value chain am I analyzing?” That helps answer the question “where do I start?” The answer is whichever value chain forms the foundation of the workflow layer scope within which a problem worth solving has been identified (typically by a manager or company saying they have a “problem”).
In the next post, we will begin the step-by-step practitioner guide to the Cavi Method at an introductory level, starting with the first phase: Problem Analysis.