“The Value Chain” - How to use this Harvard Professor's concept to grow your wealth…
Harvard Professor Michael Porter spent much of his career devoted to analysing competitive strategies.
And in the early 1980s, he developed a concept called, “The Value Chain”.
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 higher returns to investors.
Today I'm going explain this concept and why you should look for companies that demonstrate a quality “Value Chain”.
It’s a buyers market right now!
If you’re not sure what to buy on the JSE or where to look, then I strongly suggest you consider Francois Joubert’s analysis of the markets.
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 Taiwan Semiconductors (TSMC), using designs licensed from ARM, a UK chip manufacturer.
Then, they’re assembled into an 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.
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 Return on Invested Capital (ROIC).
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
In Apple’s case…
Apple has consistently generated a high ROIC of between 30%-40% over the past 5 years, with a 10 year average of just over 30%.
And Apple’s returns over these periods?
285% (5 year) and +550% (10 year), respectively…
Proof that “the Value Chain” is a powerful and profitable investment concept.
I believe the next decade on the stockmarket is all about value and it will be these companies that flourish and grow. If you want to know where to find value on the JSE, then you need to consider investing in Real Wealth research, as it has the potential to make you double even triple digit returns.
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