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The world of entrepreneurship requires you to plan for uncertainties. You cannot wait for some mishap to decide on the redressal method; you have got to stay on your toes and take precautions.

So, just after you have started with your business; just after your idea isn’t an idea anymore, you need to start thinking about all the sides of the story. No matter how sad, horrifying, or dumb the possibilities may seem, you have to be ready with your precautions.

Vesting is one of those preventive measures. It helps deal with the situation of a cofounder walking away. VCs also ask for a vesting schedule because a founder leaving early-stage is seldom easy to deal with. Not only will you be left with the burden of finding a new partner but also the risk of diluting your equity because they have the legal power not to give back the shares. Horrifying, isn’t it?

Vesting helps you manage this situation. So, let’s talk more about it.

What is Vesting?

Founder vesting is the mechanism by which business founders secure rights to their company’s shares without actually getting them, that is, on the condition of acquiring them gradually according to a pre-decided schedule.

If you opt for vesting, you won’t outright get your share in the company; these will rather be reserved for you to acquire in due course.

In simple terms, founder vesting refers to the gradual process of giving business founders ownership to their company’s shares. Founders earn full ownership of their shares gradually over the time decided in the founders agreement. This means that they have to stay at a company for a certain amount of time before they can own all of their equity.

One thing to know here is that vesting follows a schedule agreed on by all the parties, so no one can take your shares away unless you leave or have to leave the company. In other words, you will have to earn your share by working for the company for a pre-specified duration. If you fail to do so by any chance, the reserved portion (that is not acquired) is taken back. 

Why Is Vesting Important?

Vesting is a clause in a founders agreement or shareholders agreement that gives the company the option to repurchase a shareholder’s unvested shares at a discount in the event that the founder terminates employment. An example of this might be if a company has a three-year vesting schedule for each founder. If a founder leaves the company after two years, then the company has the right to repurchase the unvested shares at a price equal to the price on a given day times the total number of unvested.

Although this seems harsh to new founders, having a vesting agreement is mandatory for new businesses as:

• It gives power to the company to take shares back from the shareholders if they don’t fulfill their side of the bargain.
• It protects the company from losing a considerable part of its equity when a shareholder leaves without fulfilling its duties.
• It prevents other founders from the “free rider” problem that would arise if a founder leaves early without contributing much to the company.

Let’s understand this better with an example.

Let’s say founders A and B start a company named XYZ. They manage to raise some capital against 10% of the equity of the company. The rest 90% is divided equally between them without vesting. Now, it’s been a year since the company started. They are scaling rapidly; everything is going well, but A decides to leave one day. Founder B, the investor, and the top executives are all worried about how they will fill A’s shoes.

However, we have one other problem here. A is not legally responsible for giving his equity share (a whopping 45%) back. So, when taking on a top-notch employee to replace A, they have to dilute B’s equity and even that may not be sufficient. Also, if the company scales up in the future, A will benefit without contributing to the business; that is, A will be a free-rider.

Now, consider another scenario where A and B opted for vesting. So, they don’t get their shares outright; they will be granted over four years. They decide that each receives a percentage of their equity unlocked every year for the next four years; that is, 25% of each of their total equity (45%) is unlocked each year.

If A leaves now after one year, they get only 25% of their share, around 11.25% of the total equity. This gives A the incentive to stay more and offers some protection to B from too much dilution in case A leaves, and they need to hire someone. Also, investors feel assured now that the chances of a founder leaving and the company shattering are less.

Terms Related to Vesting

To understand how vesting exactly works, you need to know a few basic vesting terms:

• Vested Stock: Stocks that cofounders acquire in exchange for their services and goodwill towards the business are called vested stocks. These cannot be taken away usually even after you leave the company.
• Unvested stock: They are the stocks not yet acquired by the cofounders but will be in due course if they keep working with the company. Unvested shares get converted into vested shares with time; that is, the portion of unvested shares decreases, and vested ones increase. However, if a founder leaves before the vesting duration is over, further vesting of these stocks will be stopped.
• Vesting schedule: A vesting schedule states the timeline when the share forfeiture restrictions lift from your shares partially and fully. Consider it as a plan that determines the portion of your company’s share you own at a particular point in time. It describes how much of your unvested shares will convert into vested ones at what point in time.
• Cliff: Cliff is the minimum time for which you need to stay in the company to acquire any stocks. It is the period after which your shares start vesting.
• Reverse dilution: Reverse dilution happens when the stocks reserved for a shareholder are returned to the company after they have violated the agreement and left. This act increases the ownership of all the other shareholders in the company.

How does Vesting Work?

The vesting is a practice in which a founder’s equity in a startup is granted in stages over time.

Let’s understand the nature and working of a vesting clause using an example. Following is a typical vesting clause in a founders’ agreement.

“Each Founder’s percentage interest in the company will vest pursuant to a four (4) year vesting schedule beginning vesting start date, which will vest 1/48th per month in exchange for continuous and consecutive service to company. Additionally, the vesting schedule will be subject to a one (1) year cliff. If a percentage interest in company is owned by non-Founders during the vesting schedule, each founder will immediately receive 12/48ths of the percentage interest. If a Founder who is subject to a vesting schedule departs company prior to full vesting of his or her shares, the remaining portion of any unvested shares will be returned to company.
Vesting will occur on the basis of following schedule:
Until and through (first vesting date) neither founder’s shares will vest
On and not before (first vesting date) 25% of each founder’s shares will vest
On and not before the (second vesting date) 50% of each founder’s shares will vest
On and not before the (third vesting date) 75% of each founder’s shares will vest
On and after the (fourth vesting date) i.e. on end date each founder will be 100% vested.”

This is a uniform four-year-long monthly vesting schedule with a one-year cliff. It states that an equal portion of a founder’s share will vest each month in such a way that the shares are fully vested in four years or 1/48th of their shares will vest each month for the next four years.

However, this clause also talks about a one-year cliff. The cliff period is the time when your vesting schedule is in sleep mode and is not in operation. This implies that no share will vest in the first twelve months after your agreement comes into being. The whole 25% of your shares will vest together on the first anniversary of the agreement.

After this, the vesting schedule operates normally, and 1/48^th of your shares vest each month. This way, at the end of the first year, you have 25% of your shares vested, 50% at the end of two, and 100% at the end of four.

What if You Leave the Company before All Your Shares Vest?

If you leave the company before the period of vesting (4 years usually) ends, all your unvested shares will be forfeited or bought back at a nominal price. While you can keep your vested shares, the unvested ones disappear into ether, increasing the other shareholders’ percentage ownership. This is called reverse dilution.

Suppose you started a company with three other people, and each of you gets a 25% share in the company. These shares will be vested according to the typical 4-year schedule with a one-year cliff. So, each of you will be 25% vested by the end of one year and 37.5% vested by 18 months. This implies that everyone will own 9.375% of the company by the end of 18 months.

Now, if you decide to leave the company, you get only 9.375% of it. Further vesting of your shares will stop and your remaining 15.625% shares will be bought back by the company at a lower cost or at a fair market cost.

Usually, the remaining shares are distributed to other shareholders based on their existing shareholding ratios. That is, everyone else will get extra 5.208% shares.

One thing you need to remember here is that the vesting schedule is dormant for the first year. So, if you leave after 11 months, you receive nothing.

What if You Go for Fundraising before the Vesting Period is Over?

Investors, especially early-stage VCs and angels, ask you to draw a fresh vesting clause in the shareholders’ agreement. A typical vesting clause in a shareholders’ agreement looks like this.

“All stock and stock equivalents issued after the Closing to employees, directors, consultants, and other service providers will be subject to vesting provisions below unless different vesting is approved by the majority (including at least one director designated by the Investors) consent of the Board of Directors (the “Required Approval”): 25 percent to vest at the end of the first year following such issuance, with the remaining 75 percent to vest monthly over the next three years. The repurchase option shall provide that upon termination of the employment of the shareholder, with or without cause, the company or its assignee (to the extent permissible under applicable securities law qualification) retains the option to repurchase at the lower of cost or the current fair market value any unvested shares held by such shareholder.”

This clause is similar to the one in the founders’ agreement. However, unvested shares of the leaver are typically bought back at a small pre-decided price instead of being forfeited.

While drawing the shareholders’ agreement, you may also ask for a portion of your shares to be vested at the time of enforcement of the agreement in exchange for your long contribution to the company.

“The outstanding Common Stock currently held by ______ and ______ (the “Founders”) will be subject to similar vesting terms provided that the Founders shall be credited with [one year] of vesting as of the Closing, with their remaining unvested shares to vest monthly over three years.”

What if Your Company is Acquired before All the Shares Vest?

If you find a good buyer for your company and decide to sell it before the vesting period is over, you may have to stay back and work for the remaining duration. However, if the acquiring company fires you during this time, the vesting of your shares will get accelerated.

“In the event of a merger, consolidation, sale of assets, or other change of control of the company and should an employee be terminated without cause within one year after such event, such person shall be entitled to [one year] of additional vesting. Other than the foregoing, there shall be no accelerated vesting in any event.”

Acceleration of shares is the automatic conversion of unvested shares into vested ones caused by certain triggers. Usually, this trigger is a merger or acquisition of the company.

 There are two types of acceleration:

• Single trigger acceleration: When acceleration is caused by one trigger, usually, merger and acquisition, it is a single-trigger acceleration
• Double trigger acceleration: When it is caused by two triggers, usually merger or acquisition followed by the new parent company dismissing the founders, it is a double trigger acceleration. The acquiring company changing the work location or significantly altering a founder’s role also qualifies as a trigger sometimes.

Usually, cofounders and investors agree on double trigger acceleration. This is mainly because the acquiring company wants the founders and key employees of the acquired company to stay, and help in the smooth transition of authority and consolidation of business. Unvested shares act as an incentive here.

You can bargain for single trigger acceleration, but keep in mind that this will make your business less desirable for a merger & acquisition. So, a double trigger acceleration clause with some flexibility will do you good.

The Bottomline

Now that you know how vesting works for cofounders, you must draw up the clause in your founders’ and shareholders’ agreement. We agree that businesses work on trust among the shareholders, but you don’t know what might happen in the future. Your cofounder may have to leave because of personal problems, health issues, and other obligations. Vesting facilitates the hiring of a replacement in such cases.

Remember that you don’t need to follow the typical vesting schedule. This is the most tried one but has its flaws. For instance, many startup founders feel that a four-year vesting schedule is useless because startups take around seven to ten years to start generating enough revenue and a founder leaving after four years will be disastrous. So, talk to your cofounders, discuss with experienced people, and then decide what kind of vesting agreement to enter into.

Go On, Tell Us What You Think!

Did we miss something? Come on! Tell us what you think about our article on founder vesting in the comments section.

The startup ecosystem is booming like never before. There’s disruption and behavioural alteration in almost every industry that you can think of.

But then, there are failures too.  

However, entrepreneurs are not alone. They have enough experienced people ready to work with them, help build their startups, and reduce the chances of failures. While a majority of new founders approach accelerators and incubators, you don’t always need cohort-based entities to help you in your initial startup stages. Some businesses will partner and work with you as you need.

Yes, startup studios are such organisations. Although they have been around for a while, startup studios are often confused with an involved venture capitalist and with a funding incubator. However, it has its own identity.

So, let’s decode startup studios for you.

What is a Startup Studio?

A startup studio, also called startup foundry, startup factory, and venture studio, is an organisation that repeatedly builds businesses out of market-tested disruptive ideas using its pooled resources.

In other words, a startup studio is a startup that creates startups. It is an organisation of experienced founders, investors, and experts that either develops its ideas or partners with entrepreneurs if they have a disruptive business idea. It then utilises its pooled money, expertise, and other resources like financial capital, team, strategical plans, management processes, and technical tools to help you establish the business.

You must remember that it does not work on a cohort basis like accelerators and incubators; it will partner with you just like an investing cofounder, that is, it will work with a hands-on style and expect equity in return.

However, you might not be the only founder it is working with. The startup studio might be developing several ideas and businesses simultaneously, a style of building businesses called parallel entrepreneurship. Here, yours and the other businesses are known as subsidiaries of the studio, while the studio itself is known as a holding company.

Just like other stakeholders, the startup studio mostly exits from your business when it is acquired or when you go public.

Startup Studios vs Startup Incubators vs Startup Accelerators

Since startup studios provide capital and expertise to young startups, they are often confused with startup incubators and startup accelerators. However, you must understand that all these organisations are entirely different.

While incubators and accelerators are cohort-based training and mentorship programmes, startup studios partner with individual businesses and work in the cofounder capacity; that is, they get involved in their day-to-day working. This is why they also demand huge equity in return for their services (30-60% compared to accelerators’ 7% and incubators’ no equity). Also, accelerator and incubator programmes last for a specified duration, whereas startup studios build startups from scratch and stay with them till they exit.

The stages at which you may join these programmes also differ. Incubators take in very early-stage startups when only the idea is ready, while accelerators expect a dedicated team, ideal MVP, and good traction. A startup studio’s work depends on its operating model; it may partner with an entrepreneur who just came up with a catchy business idea or the whole team when their management plan is ready. However, it usually focuses on building companies from the ground up.

Startup Studio vs Venture Capitalists

Startup studios and venture capitalists fund and guide several companies simultaneously and demand equity in return for these services. However, you must understand that their work and goals are different.

While a venture capitalist plays the role of an investor, startup studios are more like investing cofounders. Besides providing money and guidance, they get fully involved in business operations, just like your how co-founding team would do.

Also, they have various tried and tested tools collected through past experiences of building companies which they offer to founders, whereas VCs only fund, guide, and help them with networking. Although quite a lot of VCs have entrepreneurial experience, it is very much limited to top-tier VC firms. While 58% of the general partners from top VC firms have been entrepreneurs before, only 28% of other firms’ GPs have found companies.

Characteristics of a Startup Studio

Who, why, when. Since startup studios are still pretty much new, it isn’t easy to understand and separate them from the other organisations. To make this clearer, just know that they have the following distinguishing characteristics:

• Startup studios usually work from ideation to the exit of startups; that is, they build from the ground up.
• Startup building is a repetitive process for them. They build multiple prototypes, business models, products, and companies simultaneously or in quick succession.
• Startup studios develop their internal infrastructure in due course. They have management know-how, data, technical tools, and organisational strategies tailored through their past experiences, and they keep adding to this infrastructure.

How Does A Startup Studio Work?

Experienced entrepreneurs, professionals, and industry veterans generally establish startup studios. Sometimes, large corporations start these studios to efficiently invest their existing capital structure, business processes, and expertise into building companies that might benefit their projects and consolidate their position in the industry.

They usually follow the following five steps:

• Ideation: Startup studios’ teams select new problems to solve every day. They brainstorm, ideate, and come up with disruptive business ideas around the subjects at hand. Sometimes, they also take ideas from outside entrepreneurs and deliberate with them.
• Validation: Once they have decided on the ideas, they check their feasibility and scalability by conducting market research and running several pre-designed tests on them. Most studios have developed internal screening mechanisms that efficiently strain out all the unsuitable ideas. If an idea passes the test, it is validated and can be worked on. If not, studios either drop it or return it to the founder it came from and explain the reason. Also, since there is no innovation bias involved, dropping the idea is easier than it is in regular startups.
• Creation: Now, the startup studios have to convert the validated ideas into working businesses. So, they develop prototypes and make improvements in them by leveraging customer feedback. At this stage, they also formulate business plans. However, if they fail, they either need to start the ‘creation’ step again or drop the idea.
• Spinning out: When the startup studios succeed in creating the businesses, they let them spin out and work under their own executive and support team. These teams may be a part of the studio or hired from the outside, depending on the situation. However, in the case of corporate startup studios, the executive teams are usually a part of the studios’ internal team.
• Scaling-up: Now that the businesses are ready to work on their own, they raise funding and start scaling up. At this stage, the startup studios may be as involved as required or work as happy board members waiting for dividends or a big exit.

In exchange for all this capital, resources, and expertise, startup studios demand equity in the companies. Since they are much more involved than accelerators, incubators, or VCs, they expect more share in the businesses they help developing, that is, 30-60%. Corporate startup studios may also want these new businesses to be integrated into their project.

Startup Studios Operating Model

Startup studios’ working model can be categorised into two types based on where the idea comes from:

Builder Studios

A builder studio is the one that develops companies from internal ideas. It decides on the problem to solve, comes up with a solution, validates it, and creates a working business out of it. This business then spins off and functions under its management team as an independent startup. Some examples of builder studios are Atomic, Pioneer Square Labs, Rocket Internet, and eFounders.

Investor Studios

These studios partner with early-stage startup founders and provide them with adequate resources and expertise. In addition, investor studios are a part of the everyday operations of these businesses; they work on product development, recruitment, fundraising, marketing, PR, etc.

Each investor studio tailors to a different kind of requirements. Based on what they provide, they are of four types:

• 1^st Cofounder Studio Model: When a startup studio partners with an entrepreneur who has an idea but not the required team, funds, or other resources, it is on the 1st cofounder studio model basis. In exchange for around 50% of the equity, the studio validates the idea, funds the development of the prototype, prepares market strategy, builds management plan, works on product building, prepares for fundraising, and recruits executive and support team members. The entrepreneur stays in the executive position of CEO, COO, or whatever they choose. After raising funds, the startup spins out of the studio and functions on its own. Some examples of studios that work on 1st cofounder basis are Human Ventures, Pioneer Square Labs, and Madonna Venture Labs.
  
• 2^nd Cofounder Studio Model: Here, startup studio partners with a small startup whose team and business plan are ready but need help in carrying the venture forward. Sometimes, these startups have even created an MVP, gained traction for it, and are operating in ‘stealth mode’. So, startup studios actively work with them to build their products, execute business strategies, and fulfill other requirements. They get 35% equity in exchange for this. Some examples of studios that work on 2nd cofounder basis are Hangar, Expa, and Timeal.
  
• Builder Outsource Studio Model: This is when a startup studio collaborates with an early-stage startup that is ready with its team, market strategy, operational resources, and business plan but needs help in building its product. The studio works with the team to design, build, and manage the product. It is a long-term partnership and any revision, updates, or change is done by the studio itself. It takes around 10% equity in exchange for all this. Some examples of studios that work on the Builder Outsource model are Rocka, Concepter, and Spark Foundry.
  
• 3^rd Cofounder Studio Model: A 3^rd cofounder studio model is like an intersection between the Builder Outsource model and the 1^st Cofounder model. It refers to the collaboration where the original startup is ready with its team, idea, vision, and network. The studio helps only with product design and development, technical assistance, marketing, PR, and technical and product support. In other words, it works like a technical cofounder and expects around 25% equity in return. Some examples of such studios are Unstuck Labs and Beeso.io.
  

Where does a startup studio gets its capital from?

Just like other startups, startup studio usually gets their funding from VCs. But unlike usual startups, startup studios need to have a well-experienced and renowned team that the VCs can trust. This is because these studios raise money before they come up with an offering (startup) to show to the investors.

Should You Go for a Startup Studio?

Startup studios are helpful in building, growing, and scaling one’s business. As of 2019, 35% of Idealab’s companies exited through IPO or were acquired, and 5% became unicorns. Out of 415 companies create by the top 23 by 2020, 88% are still active.

Also, statistics say that the founders of previously successful businesses have 30% chances of success with their next venture as opposed to a general 10%. Therefore, one thing is for sure; you boost your chances of success by opting for a startup studio.

But is it the right choice for you?

Well, this completely depends on you, your situation, and your vision. If you lack something and would like to have someone help you with it in the cofounder’s capacity, startup studios might be the right choice for you. They can assist you with product building, PR, marketing, fundraising, etc. Their infrastructure, tools, and processes have been built after trying and repeatedly testing so you can trust them with your business. However, they require you to give up a significant portion of equity and control.

Also, opting for a startup studio means spending hours choosing the right one. When you lead an outside team into your business, they significantly impact your work culture and ethics. So, you need to be sure that your demands and expectations align with theirs.

However, if you are okay with putting this much effort and giving up equity, go for it. The startup studio will definitely help scale your business!

Go On, Tell Us What You Think!

Did we miss something? Come on! Tell us what you think about our article on startup studio in the comments section.

The market today is more competitive than ever. The players have added new attributes to competition and the value scoring isn’t limited to quality and price. Today, you need to achieve holistic excellence to make a name for yourself.

But how can you evaluate if your business activities are providing the most value to your customers while maintaining good profits? How is value generation for both customers and shareholders envisioned?

Enter the concept of value chain.

Value chain answers every question pertaining to how a business provides value to its customers and itself. It is a useful technique to evaluate business processes and identify chances for innovation.

But what is value chain and how to develop it? Let’s find out.

What Is A Value Chain?

A value chain is a series of activities carried out by an organisation to create and deliver value to the customers. It provides a company a competitive advantage by relieving the customers’ pains and providing them with exactly what they want.

It includes all the activities involved in transforming a product from idea to reality; that is, right before the procurement of raw materials till the time the product reaches its end consumer.

But, what is customer value?

The benefits that a customer receives in monetary terms in return for the price paid for a market offering is known as customer value. To create and deliver this “value”, a company conducts a series of activities, this series of activities is called value chain.

The concept of value chain was pioneered by Harvard Business School professor Michael Porter in 1985. He visualised the concept and discussed it in his influential book Competitive Advantage: Creating and Sustaining Superior Performance.

Value Chain Vs Supply Chain

Supply chain and value chain are two processes involved in bringing goods from the design board into the hands of customers. Hence, they are often confused to be the same concept.

However, both of them approach the process from a different perspective and with different goals. 

Value Addition

The main distinction between a supply chain and a value chain is that a supply chain does not have any value added. All that is being done in a supply chain is a conveyance, that is, a commodity or material is taken from one business and sent to the other, while the main function of a value chain is to add value to the commodity so that it can be presented to the customer.

Origin

The supply chain concept originated from operational management, while the value chain concept comes from business management.

Concept and Objective

The supply chain activities are planned and controlled through the process of supply chain management. This cross-functional system aims to ensure complete customer satisfaction. Whereas the ultimate goal of a value chain is to give a business a competitive edge by increasing productivity while keeping costs reasonable. For this, it uses value chain analysis.

Supply chain = supplying products

Value chain = delivering value

Porter’s Value Chain Model

Porter’s value chain model examines processes involved in the transformation of inputs into outputs. It sees a company as a chain of value-creating activities.

Porter used the concept to demonstrate how businesses add value to their raw materials to create products that are then sold to the customers.Thus, it’s crucial to maximise value at each stage of a company’s operations.

He represented a chain of activities common to all businesses, which he divided into primary and support activities. These activities are used as “building blocks” by businesses to produce a valuable product or service.

Primary Activities

Primary activities add value and give a business a competitive edge, meeting external demands. It includes all the actions that are directly involved in the production and selling of the product like procurement of raw materials, transforming it into finished product, its delivery, marketing, and services.

Inbound logistics

It encompasses actions and processes involved in getting, distributing, and storing products internally. It also involves relationships with suppliers as it is important in creating value.

Examples include material storage, warehousing, inventory management, vehicle scheduling, and returns to supplier

Operations

It includes all the processes involved in the transition of raw materials to the final product. This include processes like manufacturing, packaging, assembly, equipment repair, testing, printing, and facility operations.

Outbound Logistics

It includes activities involved in delivery of the final product to the customer, like collecting, storing, and physically delivering the product to customers. It also involves overseeing a company’s internal systems as well as external systems from consumer organisations.

Examples include finished goods warehousing, delivery vehicle operations, order processing, and scheduling.

Marketing & Sales

Marketing and sales activities involve purchase of finished goods by customers and the incentives offered to persuade them to buy the company’s products.

Advertising, branding, quoting, channel selection, channel relations, and pricing are included in marketing and sales that aim to maximise visibility, attract a marketing audience, and communicate why a buyer should buy a product or service.

Services

It involves activities that are intended to maintain the value of products and improve the customer experience. It includes add-on services, installation, warranties, refunds, and returns. The importance of after-sales service is equal to that of promotional activities.

Support Activities

Support activities are mostly centered on addressing internal needs and play an auxiliary role in primary activities. There are four support activities and increasing the efficiency of any of the four support activities benefits at least one primary activity.

Procurement

It includes processes involved in the acquisition of raw materials, tools, and other consumable goods, as well as machinery, laboratory equipment, and office equipment. It also includes actions involved in finding suppliers and negotiating contracts for goods and services.

Technological Development

Technology is used at different stages of the value chain to achieve a competitive advantage by increasing productivity or lowering production costs. Technological development includes activities relating to machinery, hardware, software, procedures, cybersecurity, and technological expertise. Research and development teams are often included in this category.

Human Resources (HR) Management

It consists of activities involved in recruiting and retaining staff (like training, building, motivating, rewarding) who will help develop, market, and distribute the product as per the firm’s business plan. Nowadays, many companies devote a Talent Management department within HRM that recruits and trains the best university graduates.

Infrastructure

It refers to a company’s support systems and involves functions that enable an organisation to run its day-to-day operations. It includes activities like general (strategic) management, planning, finance, accounting, legal, government relations, and quality management.

These elements of a value chain contribute to the equation that leads to margin calculation. Now, what are the margins?

The revenue earned by the value chain is referred to as margins.

Margin = Value Created and Captured – Cost of Creating that Value

What Is Value Chain Analysis?

Value chain analysis is a multi-purpose process that assesses a company’s primary and support activities to understand costs, identify the activities that add the most value, and set the company apart.

It aims to build or improve a competitive advantage for a business and assists in identifying places where it can improve productivity and profitability in order to increase margins.

How To Conduct A Value Chain Analysis?

Value chain analysis necessitates research and might be time-consuming to complete. But it can make a company reach milestones. Some steps involved in creating a value chain analysis are outlined below.

Identifying Value Chain Activities

The first task is to identify each step in the value chain.

In the case of primary activities, a company should specify sub-activities that create value.

For support activities, companies should determine sub-activities that build value within each primary activity.

This involves correct identification of direct activities (activities that create value by themselves), indirect activities (activities that help direct activities to run smoothly), and quality assurance (activities that ensure that direct and indirect activities meet the required standards).

Identifying And Analysing The Cost And Value Of Activities

The next step is to evaluate the value that each activity contributes to the process, as well as the associated costs.

Is the activity time-consuming? What is the price of raw material?

Using similar questions, a company can determine which practices are cost-effective and which are not. As far as value is concerned, the value must always be examined from the perspective of the consumer.

Do the materials used to build a product make it more durable or luxurious for the user? Will a company benefit from network effects and increased business if they have a certain feature?

Answering such questions helps to avoid wastage of resources on a function or part of a product or service that does not help the consumer add value.

Identifying Opportunities For Competitive Advantage

Now the company needs an overview of where it excels and where organisational changes should be made. It should begin with improvements that require only small adjustments but have a large effect. Once a company has defined and implemented the easy wins, it can move on to the more difficult tasks that might be impeding production.

In order to gain competitive advantage, a company can approach value chain analysis either by cost advantage or by differentiation advantage.

Cost advantage

This approach is used when a company attempts to compete on cost. This strategy aims to minimise the costs of the activities or the total amount of resources used as well as to develop an understanding of what factors drive those costs.

Thus, businesses should classify the cost drivers for each activity. Cost drivers mean anything that influences the cost of an activity or procedure like linkages between activities, geographical location, policy choices.

After determining the cost drivers, a company must look for ways to optimise and reduce it. The lower the cost, the more a company can push its prices down and get a cost advantage over competitors. 

Differentiation Advantage

This approach is used by companies who want to create differentiated goods or services. It takes into account all of the activities that the customer values the most using value drivers. Value drivers are similar to cost drivers, but they refer to features that customers value other than low prices like meeting customer expectations.

A company can implement this strategy to ensure that they add value and can be sustained over time as the more valuable differentiation a company has from its competition, the merrier it is for its business in the long term.

For this, a company must identify cheaper suppliers, encourage its staff with various merit-based approaches, and integrate multiple digital solutions.

Finally, there are two stages to consider when evaluating value chains.

• Interrelationships between the firm’s activities (These correlations are crucial to gaining a competitive advantage from the value chain framework).
• Relationships between internal operations and external organisations that are part of the firm’s extended value chain.

Advantages Of Value Chain Analysis

The value chain aids companies to identify and evaluate sources of cost efficiency, both positive and negative, and benefits a company in several ways.

• Boosts profit: It can improve a company’s profit margins because of efficient logistics and distribution. Increased consumer value and decreased redundancy provide the highest possible revenue to the business. For example, the marketing and after-sales facilities of Apple draw more customers and persuade them to purchase goods at higher rates.
• Enhances the quality of the offering: It can improve the market’s quality and make it more competitive. The continuous reviewing of primary and support activities and a knowledge of consumers’ tastes and preferences improves the quality of products due to heavy competition.
• Eliminates waste and provides stronger brand recognition: It helps to reduce a company’s cost by eliminating things that cost more or take up too much of an employees’ time. Also, it improves a brand’s image by consistently delivering value to the customers and looking for both differentiation and cost advantages.
• Increases sustainability: It can increase a company’s long-term adaptability and sustainability while enhancing its valuable offerings. This can be done by mapping the value chain process and eliminating menial activities that don’t contribute to the final product.

Disadvantages Of Value Chain Analysis

Although there are many benefits to performing a value chain analysis, there are some significant disadvantages as processes that seek to increase work efficiency and add value while reducing costs can have some drawbacks.

• Loss of target: The larger strategic view can be lost if too much attention is paid to microdata. Value chain analysis aims is to analyse a company’s operations, segment by segment but sometimes it’s easy to lose sight of how the various events interact in general.
• Difficulty in developing chains: Even though value chain analysis is conducted in different stages, its creation is a difficult task. The data collection process is slow and tedious, determining what adds value or not can sometimes be subjective (due to unreasonable customer behavior), and deploying the plan can be labor-intensive and time-consuming.
• High implementation costs: Value chain analysis is a never-ending operation, as competition never stops, and constant benchmarking is needed to be one step ahead of others. The implementation cost for an organisation that has never used value chain analysis before can be high.
• Maintaining the process can be a difficult task: To design a value chain is just half the battle. It can take up so much time that the staff won’t be able to concentrate on other tasks.

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