The Value Chain and Cost Analysis

The behavior of a firm's costs and its relative cost position stem from the value activities the firm performs in competing in an industry. A meaningful cost analysis, thus, examines costs within these activities and not the costs of the firm as an entire. Each value activity has its own cost structure and the behavior of its cost may be affected by linkages and interrelationships with other activities both within and outside the firm. Cost advantage results if the firm achieves a lower cumulative cost of performing value activities than its competitors.

The starting point for cost analysis is to define a firm's value chain and to assign operating costs and assets to value activities. Each activity in the value chain involves both operating costs and assets in the form of fixed and working capital. Purchased inputs make up part of the cost of every value activity, and can contribute to both operating costs (purchased operating inputs) and assets (purchased assets). The need to assign assets to value activities reflects the fact that the amount of assets in an activity and the efficiency of asset utilization are frequently important to the activity's cost.