Value Chain

Fundamentals

The purpose of business firms is to create maximum economic value (profit) for their owners through producing and trading goods and services. But in order to create value for shareholders, firms must first create value for their customers. This happens when customers perceive the product or service they purchase more valuable than the price they pay for it—such as when they walk out of the store with their purchase, thinking “this was a good deal.” But having customers willing to pay for a company’s products is not enough by itself to create value for shareholders. The cost of producing and trading goods and services must also be lower than the price customers are willing to pay. So the fundamental task of a firm’s managers is to make the gap between what customers are willing to pay (price) and cost of providing products as wide as possible.

Widening the gap between customers’ willingness to pay and the firm’s costs can be achieved in two basic ways: lowering costs and increasing customers’ willingness to pay by enhancing the quality of products and services or some other factor (such as customer service) so that a higher price can be obtained. Examples of both of these can be found in the airline [Page 924]industry. This is how the value chain theory can be applied: It shows managers how to tailor all of the firm’s activities systematically to either lower costs or to enhance customers’ willingness to pay. Southwest Airlines and Ryanair are good examples of lowering costs in all of their activities from ticket purchase to baggage handling to onboard service and thus creating value for their customers in the form of low prices. A regional Canadian carrier, Toronto-based Porter Airlines, is an example of increasing the customers’ willingness to pay through its activities. Porter has done it by offering convenience (operating an airport next to downtown) and added services (a comfortable lounge for all passengers, complimentary alcoholic beverages on board, etc.).

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