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Why companies that demonstrate a “Value Chain” are more likely to generate you big profits

by , 03 April 2017
Why companies that demonstrate a “Value Chain” are more likely to generate you big profits
Have you ever heard of the “Value Chain”?

Well, it's an old concept developed in the early 1980s by Harvard Professor Michael Porter.

Porter spent much of his career devoted to analysing competitive strategies.

In his 1985 best-seller book, "Competitive Advantage”, Porter discussed the power of the “Value Chain” and why companies that get this concept right are more likely to generate you big profits.

Let me explain…

The Value Chain explained…

 
The “Value Chain” is a set of activities that a company implements to create value for its customers.
 
The more value a company creates, the more profitable it is likely to be. And when a company provides more value to customers, it builds a competitive advantage.
 
The important thing to note about the Value Chain is…
 
A company is unlikely to perform all the activities required to deliver a product or service to the customer, on its own.
 
Therefore, a company’s value chain will be a part of a bigger, industry-wide chain.
 
Apple is a good example of a company with a quality Value Chain.
 
You see, Apple designs, sells and provides support for smartphones, but the parts it uses, are sourced from global suppliers.
 
For instance, the central processor is made by Taiwanese Semiconductor Company (TSMC), using designs licensed from ARM, a UK chip manufacturer.
 
Then, they’re assembled into iPhone chassis by Chinese company, Foxxcon, while the raw materials are processed by other companies.
 
The point is, each of these activities add more value and are more profitable than others.
 
Fortunately, Apple occupies a highly profitable position in its Value Chain as it delivers the final product straight to customers, while keeping costs low by using overseas companies to build its product.
 

A South African company that demonstrates a quality and profitable Value Chain

 
Take Africa’s leading branded food services franchisor, Famous Brands for example.
 
The company has a Value Chain of 18 restaurant brands with a network of over 2,500 restaurants in over 15 countries – including international exposure in the UK, India and the United Arab Emirates.
 
Over the years, Famous Brands has enhanced its Value Chain by acquiring supply chain businesses. Joint-venture partnership with Coega Dairy for the supply of cheese products to the group.
 
For example, Famous Brands owns…
  • A stake in Java Lava Beverage Manufacturers - A coffee roasting and packaging business, and in
  • A stake in The Bread Basket.
  • A juice, ice-cream, sauce and spice plant
  • A 75% stake in a local meat processing plant, Cater Chain, to bulk up its supply chain to fight overseas competition
Instead of paying suppliers for products to sell through its franchises, it produces them itself – therefore cutting costs, while still proving the same customer value.

So how do you identify companies with a profitable Value Chain?
 
The Value Chain is used to identify companies that can sustain profit growth in the future.
 
And to find this out, Porter focussed on a formula called Returns on Capital (ROC).
 
The rationale behind this formula is, the higher the profit margin on each sale, and the lower the capital needed to generate a sale, the higher the return on capital, and therefore, the more profitable a business is.
 
So if a company can maintain high, sustainable returns on capital, then it shows the company is…
  • Satisfying its customers as they keep buying
  • Keeping rivals at bay as it can charge/keep costs low enough to maintain or increase profitability
For example, take a look below…
 

Apple’s consistent high ROC, as well as Famous Brands increasing sustained high ROC is proof of both company’s quality and profitable Value Chains.
 
In fact, since 2007, Apple’s shares have risen 1,066%, while Famous Brands has risen 1,000%.
 
Until next time,
 
Always remember, knowledge brings you wealth,
 
Joshua Benton, Real Wealth
 
P.S. Identifying companies that have quality and profitable Value Chain is just a small part of my market-beating Real Wealth strategy. So if you’d like to discover more JSE companies with strong Value Chain, then I urge you to join Real Wealth
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