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How are the goods and services that we all consume created? Usually many activities are involved in securing basic raw materials and turning them into valuable products or services. The set of linked, value-creating activities, ranging from securing basic raw materials and energy to the ultimate delivery of products and services, is called the value chainAn organization’s set of linked, value-creating activities, ranging from securing basic raw materials and energy to the ultimate delivery of products and services.. Although there may be only one organization involved in a particular value chain, usually there are many. Mayo Clinic’s value chain, for example, would include not only the hospital but also the suppliers of pharmaceutical products and medical supplies, the manufacturers of diagnostic equipment, the private-practice physicians whose patients use the Mayo Clinic, and the ambulance services that transport patients to the hospital. The value chain for Walt Disney Studios would include upstream contributions such as screen writing, film studio construction and maintenance, set design and construction, costume design and production, travel arrangements for shooting scenes on location, lighting technicians, film crews, and acting talent. Once the film has been produced, the downstream contributions include advertising personnel; TV, radio, and print media; film distributors; theater companies such as AMC Theaters; DVD producers; video rental stores such as Hollywood Video; and DVD retailers such as Best Buy.
What is the role of Gap, Inc. in this value chain? As the company’s Web site explains, “We’re not a manufacturer. To produce our clothes, we contract with garment manufacturers around the world.” What Gap does is design its clothing lines, outsource the manufacturing, market the products, distribute them to retail stores where they are sold, and provide customer service. Quoting again from Gap’s Web site, “From a design concept born in New York by our product designers, to an in-store display in one of our more than 3,000 stores around the world, each Gap, Banana Republic, Old Navy, and Forth & Towne product goes through a multistage process before reaching our customers.” That multistage process is the company’s value chain. In order for any organization to most effectively achieve its goals, it is important for its managers to understand the entire value chain in which their organization participates. This understanding can help managers ask, and answer, important questions about their organization’s strategy. Should the company concentrate on only a narrow link in the value chain, such as design or retailing? Or should it expand its operational scope to include securing the raw materials or manufacturing the product? Are there opportunities to form beneficial linkages with suppliers, which come earlier in the value chain? Or with customers? These questions involve fundamental, strategic issues about how an organization can best meet its goals. Although many factors affect such decisions, one important factor concerns the costs incurred in creating value in each link in the value chain. In order for a company to achieve a sustainable competitive advantage, it must either (1) perform one or more activities in the value chain at the same quality level as its competitors, but at a lower cost, or (2) perform its value chain activities at a higher quality level than its competitors, but at no greater cost. Understanding the value chain, and the factors that cause costs to be incurred in each activity in the value chain, is a crucial step in the development of a firm’s strategy. These cost-causing factors are called cost driversA characteristic of an activity or event that results in the incurrence of costs by that activity or event., and we will have much more to say about them throughout the text. The overall recognition of the importance of cost relationships among the activities in the value chain, and the process of managing those cost relationships to the firm’s advantage, is called strategic cost managementOverall recognition of the cost relationships among the activities in the value chain, and the process of managing those cost relationships to a firm’s advantage.. Issues in strategic cost management will arise in a variety of contexts as we pursue our study of managerial accounting. Theory of Constraints Along with a value-chain analysis, managers should carefully examine the chain of linked activities with a view toward identifying the constraints that prevent their organization from reaching a higher level of achievement. Sometimes called the theory of constraintsA management approach that focuses on identifying and relaxing the constraints that limit an organization’s ability to reach a higher level of goal attainment., this approach seeks to find the most cost-effective ways to alleviate an organization’s most limiting constraints. When binding constraints are relaxed, the organization can reach a higher level of goal attainment. For example, suppose a delay occurred in the design process for Gap’s line of summer clothing because too few designers were assigned to the project. This could result in a delay in contracting for the manufacturing of the summer line, which could ultimately delay the delivery of the products to Gap’s many retail outlets. In this context, the design process is a bottleneck operation, meaning that it slows down the progress of Gap’s products through the retailer’s value chain. By assigning even one or two more designers to the summer clothing line, the delay could perhaps have been avoided. Exercise 1-28 | |||||||||||||
