1) With reference to the above statement, describe what is meant by the value chain.
2) Explain how the value chain may be used to estimate costs.
3) Describe each segment of the value chain and explain why information about costs in the various segments of the value chain can be useful to managers.
4) Identify and explain the major purposes of value chain using examples from your selected annual report/ annual review of one of top 100 manufacturing companies listed on ASX.
REQUIRED: Prepare estimates of the following that were destroyed by the flood.
- a) The cost of Work in Process.
- b) The cost of finished goods inventories.
"The value chain provides a useful framework for examining the areas where costs are incurred within a business. The value chain is a set of linked processes or activities that begins with acquiring resources and ends with providing goods and services that customers value".
Segments of the Value Chain
Value chain refers to process that is integrated with supply chain process to helps the management accountant to save the costs incurred while performing these activities. Value chain process divides the whole process into multiples activities and they are further divided into primary activities and support activities. The objective of value chain is to minimize the cost and maximize the operational efficiency through identification of wasteful activities and remove them through introducing the activities that adds value to the product.
This report will briefly explain the concept of value chain provided by Porter and how it can be used to estimate the costs. All the segment or parts of value chain are explained together with application of its elements in Rio Tinto, a manufacturing company in Australia.
- Value Chain Meaning
The value chain can be regarded as the basic tool that is used for cost analysis by developing a value-chain of all the activities that are involved in creation of a particular product or service. This approach is widely used in accounting to identify the value creating activities and eliminating the unnecessary activities for attaining operational efficiency. This type of costing considers all the activities involved in a product creation right from acquisition of resources till its final delivery. It is regarded to be an effective management accounting tool that is largely been used by the accounting managers to assess the cost behavior from its value activities (Yang and Shang, 2007). It helps in developing an analysis regarding the internal and external activities of a firm and assessing their contribution in enhancing the value of a product or service created. As such, the wasteful activities can be identified accurately that helps in reducing the costs and maximizing the operational efficiency.
The use of value chain enables a company to improve its strategic position as follows:
- It leads to improvement in the product quality through developing an adequate understanding of the customer requirements
- It provides an effective way for examining the competitive cost position of a firm and improving its strategic position thereby enabling it to attain competitive position
- It helps in reduction of time for creating a product or service by elimination of the unnecessary activities
- It leads to reduction in the cost by placing focus on the significant areas requiring minimization of cost and thereby leading to re-establishment of the value chain (Cadez, and Guilding, 2007).
- Use of Value Chain for Cost Estimation
Value chain is regarded as the combination of activities that leads in development of valuable product or service for a firm. The identification of different activities involved helps in estimating the cost that are present on the value chain. The identification of the primary and support activities related with the creation of products helps an accounting manager to develop different strategies for reducing the cost associated with each activity (Hutaibat, 2011). The strategies that are developed should lead in keeping the value of the product created to be constant and only aims at reducing the cost. The identification of the cost drivers associated with each activity helps in estimation of the costs which can be operational, executional or structural. The accounting managers by developing the strategies to eliminate the factors that results in enhancing the value chain activities can significantly attain cost efficiency (Peter, 2011).
- Information used in costs depicted in various segments of value chain for managers
The various segments that lead in developing a value chain for gaining information about the costs can be described in detail as follows:
Identification of the value chain activities and segregating them into distinct activities
This stage of the value chain consists of identifying the different types of value chain activities that need to be carried out in the process of designing, manufacturing and distribution. The activities should be identified distinctly if it represents a significant proportion of the overall cost.
Application of Value Chain in a Manufacturing Company
Evaluating the importance of different activities in the overall cost of the product
The development of an optimum chain of valuable activities for product development requires significant cost analysis to be carried out for identification of the cost associated with carrying out each activity. This is followed by determination of the effectiveness of the company in investing in various activities of the value chain (Kirli, 2011).
The identification of the useful and wasteful activities depends on benchmarking the unit costs required for carrying out each activity in comparison to those of the competitors.
Identification of the cost drivers
The identification of the costs to be incurred in carrying out each activity of the value chain depends on structural, executional and operational cost drivers. The structural cost driver determine the cost incurred in activities such as involved within the use of technology and other supply chain costs. The executional cost driver depends on cost involves in designing, quality check and adopting the use of continuous improvement programs. The operational cost driver includes the cost that are dependent on the factors such as number of products, number of orders of customers and various number of parts.
Identification of Opportunities for reducing costs
The identification of the cost drivers is followed by development of effective business strategies that helps a firm in attaining the cost advantage by having a control on the various drivers of the cost. A firm should aim to reduce the costs associated with each value chain activity and enhancing the value of product or service created (Mei, Han and Chen, 2009).
4.Purpose of Value Chain in Rio Tinto
Rio Tinto is one the major producer of iron ore in Australia and it falls in the list of ASX top 100 companies. It uses iron ore in manufacturing of steel that requires integrated value chain process. Value chain process is required within the manufacturing of steel because process of steel manufacturing is very rigorous and requires proper handling and standardized value chain integrated in the supply chain process. There is huge cost involved in the process of steel manufacturing that creates huge responsibility on the cost manager to control the overall cost of production and further cost expenditure till the final delivery to the customers. The value chain process used in the steel manufacturing plant is same as model proposed by the Porter with some differences in activities and their application (Rio Tinto: Annual Report, 2017). Value chain process used at Rio Tinto for the production of steel is as follows:
Primary Activities involved at Rio Tinto for steel manufacturing and sales
Primary activities refer to all those activities that are directly related to the conversion process of raw materials to make the finished goods and to sales of finished goods. It is the reason why primary activity is grouped into two main activities one is product related and market related. Product related activities add values to the product and market related activities add values to the product and services transferred to the customer. There are five primary activities that are performed by Rio as their value chain process:
- Inbound Logistics: In order to start the production of steel there is requirement of raw material and under this activity all such process is performed. It includes handling of raw material and its storage including transfers within the various departments.
- Operations /Production Management: This process is quite complex as it requires raw material handling, processing it and make the proper storage of it. Rio Tinto has defined set of steps under this process that needs to be performed to complete this process. Value chain process provides Rio Tinto with ease of operations otherwise this process will be most difficult process.
- Outbound logistics: This process includes planning, distribution, warehousing and any other activity requires making the goods available to the customers at the right place. As Rio Tinto has bigger supply chain process it is easy to handle this activity and derive most of the value from this activity.
- Marketing and Sales: This activity helps Rio Tinto to add value to the process of marketing such as price management, domestic sales and other activities that add values to the sales process.
- Service after sales: This process helps to add value to the product such as quality aspects, delivery aspects, pre/post sales, warranty services etc (Rio Tinto: Our Value Chain, 2016).
Auxiliary or support activities performed in process of steel manufacturing by Rio Tinto
Supports services includes process such as material management, technology management, human resource management, services management, finance management and project management. All these activities helps to add value to the product and also make sure that no such activities are performed that does not add value to the product. All the process performed under the support activities are not directly involved in the conversion process but helps to support the primary activities. Without the use of support activities primary activities are useless or they will not provide the optimum value to the whole supply chain process (Rao, 2015).
The overall analysis shows that value chain analysis helps to reduce the cost incurred during the process of supply chain and also identifies the activities that do not add value to the product. So it can be said that value chain is the essential part of the supply chain process and it must be includes by the manufacturing companies.
Cadez, S. and Guilding, C. 2007. Benchmarking the incidence of strategic management accounting in Slovenia. Journal of Accounting and Organizational Change 3 (2), pp. 126-146.
Hutaibat, K. 2011. Value Chain for Strategic Management Accounting in Higher Education. International Journal of Business and Management 6(11), pp.206-218.
Kirli, M. 2011. The Implementation Of Strategic Management Accounting Based On Value Chain Analysis: Value Chain Accounting. International Journal Of Social Sciences And Humanity Studies 3(1), pp. 307-321.
Mei, X., Han, Z. and Chen, H. 2009. Study on the Cost Management Based on the Cooperative Value Chain. International Journal of Business and Management 4 (6), pp. 17-22.
Peter H. 2011. Managing Value Chain Strategy. Journal of Management and Marketing Research, 9, pp.1-11.
Rao, N. 2015. Value Chain Model For Steel Manufacturing Sector: A Case Study. International Journal of Managing Value and Supply Chains (IJMVSC) 6 (4), pp. 45-53.
Rio Tinto: Annual Report. 2017. [Online]. Available at: https://www.riotinto.com/documents/RT_2017_Annual_Report.pdf [Accessed on: 30 October 2018].
Rio Tinto: Our Value Chain. 2016. 2016 Sustainable development report. [Online]. Available at: https://www.riotinto.com/documents/RT_SD2016_our_value_chain.pdf [Accessed on: 30 October 2018].
Yang J. and Shang W. 2007. Finance Management Based on Value Chain Management. International Journal of Business and Management 2(5), pp.101-103.
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