Value chains describe how a group of companies in an industry do business together, building up on each other and adding value to a product or service before it is sold to end-users. For simplification purposes a value chain is often depicted graphically as a linear series of activities. However, a trunk and branch structure, or even a web structure can be more appropriate when the business relationships are more complex and varied than the simple “buy from the previous link in the chain, sell to the next link”.
Why do we care about value chains? The only constant in life is change. Analysing an industry and deconstructing its value chain is an effective way to identify the main players and the roles that they fulfil. This in turn will help define the business areas where you want to compete, as well as alternative business opportunities and business models. It sharpens your positioning and triggers tough but important questions: why do my business activities start here, and why do they stop there? It also helps you anticipate and prepare for major industry transformation.
Although the terms business model and value chain are often used interchangeably, business model is a related but different concept. More often than not, business plans are fuzzy in terms of what their role and their operation mode in the value chain is. This is where business models come in. A business model focuses on one link or one company in the value chain and describes its operational model: how it does business, what it buys from other players, what its own contribution is, and who it sells to.
Business models also address additional aspects, such as:
- What are the main activities undertaken by a company?
- Who is the company selling to? Who is selling to the end-user? Who owns the end-user? Which channels are used? Which brand appears on the service or product? Who is billing and collecting money from the end-user? How are revenues shared between players?
- Who invests in what (assets)? How are other costs shared between players (e.g. marketing, customer care)?
- How is the money flowing between the players? Who is paying whom? Who is paying you?
How you generate revenues and who you sell to are questions that are not always easy to answer. For instance, although many Internet portals provide services to end-users, they do not generate revenues from them directly but are financed by third party advertisers, who themselves try to sell their products to end-users.
There are also examples from brick and mortar businesses, for instance a coffee shop providing Internet access over WLAN. Is the coffee shop paying the Internet Service Provider (ISP) for the value provided by installing WLAN in the shop, which encourages customers to stay longer and consume more? Or vice-versa is the ISP, who has financed and installed the WLAN access points, paying the coffee shop a fee for the space and right to use the shop premises? Who is paying whom? Both are possible. The key question are: who collects money from end-users, and how are costs and revenues split between the partners?