Strategies to capture the entire value chain for marketing financial product and services

Marketing of new business and increasing market share

2.5.1. Value Chain Finance

What is Value Chain Finance?

Value chain finance refers to financial products and services that flow to or
through any point in a value chain that enable investments that increase
actors' returns and the growth and competitiveness of the chain. Whereas
financial transactions within a value chain are not new (production finance
could be considered "value chain finance"), several emphases distinguish a
value chain finance approach. These include improving finance at specific
points in the value chain to increase the competitiveness of the entire value
chain and involving multiple actors and leveraging relationships to lower or
mitigate risk. Taking a value chain approach entails considering the risks
and returns of the finance supplier along with the risk and returns of the
value chain actor demanding finance. As Figure 1 illustrates, value chain
actors themselves, banks, microfinance institutions, other non-bank
financial institutions, or a combination of these actors can provide or
facilitate financing to a value chain. These actors may participate in a value
chain financing arrangement for different reasons, and these reasons
determine the ways in which they are willing to facilitate financing for a
value chain upgrading investment.
Image

Often in value chain finance, some form of strategic alliance is established

between the financial provider and one or more value chain actors to
reduce transaction costs and lower risks that otherwise impede access to
traditional financial services. In such arrangements, private sector actors
may directly finance a particular investment or cash flow need, or they may
help facilitate financing from a more formal financial institution. It is
important to understand how value chain governance, relations and
linkages are structured to respond to market opportunities, because these
factors will determine the viability of a financing arrangement. Value chain
finance works best where there is strong end-market demand, as well as
transparency, trust and strong and repeated inter-firm transactions. The
stronger the relationships, the more readily players in the value chain can
rely on their relationships to facilitate access to finance. The most common
ways value chain actors facilitate financing include:

 Screening Borrowers: Value chain actors may have useful

information about potential borrowers. This information can help
financial institutions screen for reliability, evaluate profitability and/or
assess the risk of default.
 Disbursement/Repayment of Loans: Value chain actors may play a
direct role in loan transactions. They may be positioned to disburse
loans on behalf of the financial institution (in-kind or cash) and loan
repayments may be channeled through them as well. These roles
can help to lower transaction costs and reduce likelihood of arrears
and default.
  Default Risk/Collateral: Value chain actors may provide a form of
"soft" collateral. Unlike "hard" collateral such as land titles, "soft"
collateral can be in the form of direct (formal or informal) guarantees
or co-signing, assigning value to inventory in a warehouse, etc. Value
chain actors may also provide some alternative which is acceptable
to a financial institution in the case that legal collateral is not available
to secure the loan. Purchase orders and buyers' contracts may
provide a reasonable guarantee of repayment to the extent that a
financial institution would waive traditional requirements. Even when
buyers' contracts are not transferable (and thus are not truly a
substitute for collateral), they can be important nonetheless to the
lender, since they signal creditworthiness and thus decrease the
default risk[1].

Demand for Finance within Value Chains

Value chain finance is useful for ensuring that businesses have liquidity so
they can meet market demands - whether that be to maintain or expand
operations or invest in upgrading to access new market opportunities. The
demand for financing by businesses can be varied. For example, a farmer
may borrow against a warehouse receipt to purchase a new tractor; a shoe
maker may take a forward contract to produce a new line of shoes; or an
industrial tire manufacturer may access a line of credit in order to increase
production to meet a lucrative order under a tight deadline. It is important to
consider both the financing needs of a value chain actor as well as their
ability to access financing from traditional providers. Some actors may not
be well served by the formal financial sector because of atypical financial
demands, lack of collateral, perceived or actual high repayment risk or cost
of outreach. As an example, in the cases above, the farmer may have
lacked collateral to qualify for a loan, the shoe maker's business may have
been perceived as too risky and the industrial tire manufacturer may not
have been able to rapidly access credit needed to meet tight deadlines.

Rural and agricultural enterprises commonly have the greatest difficulty in

accessing financial services from traditional providers for the reasons
mentioned above. This makes any production-level demands for financing
challenging and can limit value chain development and growth. Many of the
financial innovations which comprise "value chain finance" were developed
specifically to bridge this financial gap by lowering costs and risks of
financing for value chain upgrades. However, a recent stocktakin [2] of rural
financial innovations revealed that the most effective mechanisms were
structured to address financial gaps that are broader than a specific value
chain financing requirement. In cases where the production unit is a
household, there are often financial demands beyond the value chain
enterprise. These demands impact household liquidity as cash resources
are allocated across a set of interlinked production and consumption
needs. In such cases, value chain competitiveness can be indirectly tied to
the ability of the household, as a production unit, to access financing for
other investments and purchases and manage their overall household cash
flow needs.

These financial demands can relate to both consumption and investment

related. Households have financial commitments for both regular and
unexpected consumption and social expenses such as food, school fees,
health care and funeral expenses. Without some form of additional
financing to provide liquidity, households sometimes must divert cash from
their enterprises to meet these immediate consumption needs. This is
especially true during "lean" times of the year when household revenues
are low. This also characterizes the ways rural households manage their
own on-farm and off-farm productive activities, since rural households
typically operate enterprises not related to agricultural production in
addition to their farm activities. Off-farm enterprises such as trading and
processing farm produce or non-farm enterprises that supply households
with goods and services are important providers of rural household income.
They can also have investment requirements that conflict with agricultural
production, and farms may have to choose between the two and in turn
limit their potential returns, as well as the competitiveness of that value
chain.

As Figure 2 illustrates, the financing demands of a rural household should

therefore be viewed holistically. A financial analysis that fails to recognize
the fungibility of cash between these competing demands often results in
improperly designed financial products, low repayment rates, and
perpetuation of the perception of rural producers as poor credit risks. On
the other hand, a holistic approach to financial demands will supply finance
that allows households to comfortably meet household and non-farm
enterprise expenses as well as make investments that will increase both
their incomes and value chain competitiveness. Innovative products such
as self-managed savings and credit associations, as well as credit products
that consider an entire household's income and expenses, have helped
rural and unbanked populations to meet household demands. In other
cases of value chain finance, interested players such as buyers may feel
sufficiently compelled to help producers through advance or early
payments.

Interests and Incentives to Provide or Facilitate

Financing
Value chain finance implies that private actors are either providing a
financial service directly or facilitating finance from formal financial
suppliers. As a rule of thumb, private sector partners tend to be willing to
participate only in financial arrangements that advance their own self-
interests, usually by either improving the supply of inputs they need for
production or by securing a strategic or profitable market channel. Some
value chain actors finance others in the value chain as a means to off-set
potential risk. For example, a buyer or trader may provide working capital
loans, advances or in-kind loans to farmers to ensure the timely delivery of
a final product. Their incentive to lend is not the profitability of the loan itself
but securing the delivery of a promised good. The goal may also be to build
trust and a stable client market, or a recognition that obtaining inputs on
credit is the only way a cash-strapped farmer will be able to make the input
purchase needed to ensure quality. For similar reasons, an input supplier
may provide a line of credit to buyers to help market their products, gain
new customers, or retain existing ones by providing credit as an extra
service. A microfinance institution or bank may provide finance to actors in
a particular value chain as part of a larger strategy to diversify their portfolio
and lower overall risk due to the downturn in one sector versus another. In
addition, a producer is in effect providing financing to a buyer by delivering
their products and trusting that payment will be received once the buyer
herself or himself has been paid.

Capacity and Constraints to Provide or Facilitate

Financing
As noted, both financial institutions and private sector players (e.g. buyers,
input suppliers) are potential providers of value chain financing. There are
advantages and disadvantages to both. It is quite common for buyers and
input suppliers to directly supply financing to others in the value chain
because of the close commercial relationships they already enjoy. But their
ability to directly provide funds can be limited, particularly if doing so places
an additional burden on their own cash flow. At the same time, these actors
may be able to play a facilitative role in bridging gaps in access to financing
by other actors in the value chain. Essentially, the commercial incentives
are the same, but the requirements of facilitating rather than supplying
finance may align better with the limited capacity of these actors. As noted
above, strategic alliances are viable mechanisms to lower costs and risks
by facilitating client screening, loan disbursement/repayment and providing
some alternative collateral or collateral substitute. In contrast, financial
institutions are the most logical financial services providers, since lending is
their core business — but they have often been slow to enter
agricultural markets. Their capacity is often limited for reasons such as
geographic isolation from clients, weak internal systems or limited skills and
capacity of staff (particularly with regard to lack of knowledge about a
particular sector, market or business). Agreements between producers and
buyers — to the extent that they signal creditworthiness to lenders,
have perceived value between agreeing parties and lead to a high
likelihood that the parties will fulfill obligations — are useful channels
for advances, embedded loan disbursement/repayment functions or to
serve as collateral substitutes. Input dealers who know their clients and are
credible to lenders can assist with screening of reliable and creditworthy
producers as well as assist with (usually in-kind) loan disbursements.
Producer associations with strong internal management may access
wholesale funds from financial institutions and on-lend to members. In the
case of inventory credit, producers may pledge the value of their
production, which is stored in a warehouse, as collateral for a loan.
Increasingly sophisticated inventory credit arrangements (such as
warehouse receipts) may also be possible.

Example: In Peru’s artichoke sector, the use of written contracts

between farmers and buyers has facilitated access to formal finance
for many smallholders. The use of contracts between processors and
wholesalers, and processors and farmers clarified and documented
pricing and selling arrangements. Several formal financial
institutions lent to artichoke producers because the growers had
defined sales terms and fixed market prices for their products. In
these cases, the lender saw that the risk of lending was reduced,
because the contracts indicated a known buyer and stable market
 prices. Without a contract, most farmers said they would have no
access to formal finance.[3]
 

Types of Value Chain Finance

Value chain finance can be grouped into three main types of vehicles:
Click here to read more about each.

1. The provision of credit, savings, guarantees or insurance to or among

value chain actors.
2. The creation of strategic alliances through financing extended by a
combination of value chain actors and financial institutions.
3. The offering of tools/services to manage price, production or
marketing risks.

Value Chain Analysis

Value chain analysis is a process for identifying opportunities for and
constraints to increased competitiveness of a sector. Value
chain finance analysis prioritizes the financial needs within the context of
specific upgrades of a value chain if it is to take advantage of end-market
opportunities. This is a critical element of determining where expansion of
financial services is tied to the growth and competitiveness of a value
chain. A value-chain finance analysis looks not only at demand, but also
the incentive structures and capacities of actors to deliver or facilitate
financial access within the value chain. Additionally, constraints within the
enabling environment and financial sector as a whole that may impact the
availability of financing should be examined during the information-
gathering stage. Importantly, as financial service delivery is rarely specific
to one value chain, the value chain finance analysis should ideally identify
key financial bottlenecks that affect the growth of multiple value chains.

Value chain analysis provides information on the upgrading investments

needed to take advantage of identified end-market opportunities and
improve competitiveness. Building on this, it gathers information on
financing constraints to market opportunities from industry stakeholders,
firms and financial institutions. Interviews are conducted with financial
service providers in and outside the value chain to reveal the degree to
which financing is already available. If finance gaps exist, the analysis
probes finance providers’ perspectives on why the gaps exist. Interviews
include formal financial institutions, (microfinance institutions, banks) as
well as input suppliers, brokers and dealers that may provide working
capital loans or input supplies on credit to their clients.

Once information is obtained on the availability of and/or gaps in financing,

a schematic can be developed showing product and financial flows. This
schematic helps identify overall finance gaps that can constrain the
prioritized improvements in value chain performance.

Financing gaps are further analyzed to determine why they exist. In

general, financing is absent because potential cost or risk is seen to
outweigh the potential benefit. Financing may be absent because the
finance provider or potential borrower cannot accurately determine the
benefits of increased investment, or because the lender or borrower
correctly assesses the risk of lending and investing as too high. The
analysis of financing gaps can inform donors about what type of
intervention may be needed, and whether the interventions should be on
the financial side, the enterprise side, or both. A challenge for donors and
governments is identifying ways to support a value chain without
undermining or crowding out private-sector solutions. Interventions should
be geared toward facilitating private-sector solutions, addressing market
failures and ensuring a functioning enabling environment.

Lessons Learned in Value Chain Finance

Opportunities

There are multiple benefits which flow from successful value chain
financing arrangements. Through its ability to reduce risk and enhance
incentives, value chain finance can enable the sustainable delivery of
services, for example ensuring that farmers, brokers and wholesalers have
continuous access to a line of products they need that are delivered in a
timely manner and meet certain specifications. These arrangements can
also improve working relationships (e.g., between buyers and suppliers)
and facilitate intra-chain information that lowers the actual or perceived
risks of lending. A successful arrangement can often provide a
demonstration effect which may prompt larger-scale players and formal
financial actors to enter into a new market once the investment
opportunities are realized.

Example: In Ethiopia, financial institutions were unwilling to work with

agricultural cooperatives until a bank tapped a Development Credit
Authority mechanism which shared the risk of loans to cooperatives that
provided advances against products deposited by their members. After a
successful collaboration, the bank obtained a second guarantee, but did
not use it, going on to lend to agricultural cooperatives using their own
funds. The bank considered the partnership to be successful on its own
merits and continued their on-lending to cooperatives for subsequent on-
lending to its smallholder members.

Challenges

One challenge for value chain finance actors is the provision of longer-term
loans for capital investments. Most value chain actors supply short-term
working capital to clients that require limited monitoring, collateral or
paperwork. As with formal financial institutions, value chain actors often
struggle with weighing the risks and rewards of offering investment loans.
Value chain actors who directly provide financing are also faced with
challenges of working in a sector they know little about. There may be
costs associated with becoming involved in the lending process; they
assume risks for repayment if a guaranteed borrower does not fulfill the
repayment obligation; and they risk diverting time and resources away from
other activities that might provide a greater return and in which they have
more skills and experience. Furthermore, value chain finance takes place
within a market system and is based on commercial transactions between
value chain actors. The viability of many value chain finance mechanisms
can be limited by low or unreliable end-market demand for a product,
mistrust among actors, and unsupportive regulatory and policy
environment. Contract enforcement and side-selling are common issues
that undermine many buyer-based finance mechanisms. Additionally,
production and price risks can be major deterrents to finance if they are not
provisioned for with other risk mechanisms.

Implications for Design and Implementation

Value chain financing offers a variety of opportunities for creative program
design, including opportunities for interventions that strengthen linkages
between producers and buyers; encouraging banks to lend to value chain
actors; organizing smallholder producer associations to enable production
of high value crops; and outreach to financial institutions to design
warehouse receipts loan products.

A challenge for donors and governments is to determine ways to support a

value chain without undermining private-sector solutions. Interventions
should be geared toward facilitating private-sector solutions, addressing
market failures and ensuring a functioning enabling environment – not
becoming a player within the value chain itself. Below are some general
implications for program designers interested in expanding financial
services to value chain actors.

1. Design sustainable value chain finance interventions.

2. Facilitate information flow from the value chain to financial markets.
3. Design interventions with ‘integrated components’ that focus on
increasing access to finance.
4. Identify sources of risk reduction and new incentives.
5. Provide training and technical assistance to value chain connector
firms.
6. Introduce and link value chain firms with financial institutions.
7. Identify ways to improve access to longer-term agricultural finance.
8. Recognize the limits as well as the benefits of financing by value
chain actors.
9. Look for solutions for gender-based constraints to finance.

For more information on these recommendations, click here.

In the world of business, organizations of all shapes and sizes are swayed by the
competitive environment, which has been more challenging than ever before. For
many companies, continually examining the value they create is vitally important if
they want to retain their competitive advantage. Value chain analysis is a proper
method for drawing a critical path to increase customer value but with lower cost.

What generating a value chain plan can help is to discern inefficient areas of your
business so that you can implement suitable strategies to optimize every part of the
procedures for maximum profitability.

Table of content

 What is the value chain?

 Primary and support activities of the value chain
 Primary activities
 Support activities
 Examples of value chain
 How to generate your value chain plan to deliver your product
 Discovering cost advantages and disadvantages
 Gain competitive advantages through differentiation
 Link your value chain to the value chains of your suppliers and buyers
 In Summation
What is the value chain?
In 1985, Michael E. Porter, a professor at Harvard Business School, introduced the
concept of a value chain in his book called Competitive Advantage: Creating and
Sustaining Superior Performance. He wrote: “Competitive advantage cannot be
understood by looking at a firm as a whole. It stems from the many discrete
activities a firm performs in designing, producing, marketing, delivering, and
supporting its product.”

Value chain can simply refer to the full range of activities undertaken by a company
to produce its products and deliver them to final consumers. In every stage of the
procedures, the value of the products or services is added. The steps include
bringing a product from conception to distribution, such as buying raw materials,
manufacturing, and marketing.

There might be confusion between the concept of the value chain and supply chain.
It can simply be clarified that supply chain represents steps it takes to get a product
or service to customers, while value chain is a set of activities which a manager
looks for opportunities to create competitive advantages.

Activities of the value chain

According to Porter, a business’s activities can be grouped into two categories,
which are “primary” and “support” ones.

Primary activities
There are five components of primary activities which are crucially important for a
company in adding value and gaining competitive advantage:

 Inbound logistics: receiving, warehousing, managing inventory of all inputs

as raw materials.
 Operations: the process where finished goods or services are created by
converting raw materials.
 Outbound logistics: distributing your products to reach the final consumers.
 Marketing and Sales: planning strategies and implement them to approach
appropriate target customers. For example, the 4Ps of marketing.
 Services: all efforts and activities to enhance customer experience such as
maintenance, repair, customer service, etc.

Support activities
The name says it all, and these activities help improve the efficiency of primary
activities. When one of the below support activities is performed effectively, it
benefits at least one of the five primary activities.

 Procurement: the acquisition of inputs for the company.

 Human Resources management: hiring, training, and retaining employees
who can fulfill your business strategy, firing or laying off of workers (if
needed).
  Technological development: everything related to equipment, hardware,
software, procedures such as designing and developing manufacturing
techniques; usually used at a company’s research and development stage
(R&D)
 Infrastructure: company system, organizational structure, functions of
departments such as accounting, finance, legal, quality control, planning.

Examples of value chain

Around the world, there are many famous case studies about value chains of well-
known big firms. For many industries, value chain analysis has always been a useful
management strategy for companies to maximize efficiency in the process of
delivering final products to customers.

In Food and Beverage, Starbucks, one of the most recognized brands in the world,
is also a popular example of successfully implementing the value-chain concept. The
corporation selects the finest coffee beans all over the world from Latin America to
Africa and Asia; gains customer loyalty by providing excellent customer service, and
shows its unique identity through many creative marketing campaigns. Numerous
articles have written about the journey and how Starbucks incorporates the value
chain into its business model. Or, you can watch this video below to catch a glimpse
of the company marketing activity.

In Retail, in order to keep the costs low to its customers, Walmart constantly invests
in performing value chain analysis. This global retail tycoon regularly evaluates its
suppliers and is able to press suppliers for lower prices due to Walmart’s financial
clout and size. Also, both online and in-store experience are integrated to enhance
customer value. However, poor reputation in terms of customer service is a
weakness of this company.

In E-commerce, Amazon is one of the biggest names. This technology company’s

most notable activities are logistics, customer service, and product return. Amazon
makes plenty of investments in improving the efficiency and speed of logistics
service, which belongs to the list of its competitive advantages. For customer
service, one annual report of Amazon says “we seek to be Earth’s most customer-
centric company”, and truly the company offers exceptional customer service for its
both types of customer (sellers and buyers).

How to generate your value chain plan to deliver your

product
In the way of approaching how to perform your value chain analysis, there are two
different directions to follow, which depends on your decision of creating competitive
advantages (cost or differentiation).

Discovering cost advantages and disadvantages

If you want to understand the sources of your cost advantages and disadvantages to
be cost-competitive, then this is the right approach (Amazon and Walmart are good
mentioned examples). You can also know what factors drive your cost while running
your business. Basically, you should go through 5 steps:

Step 1: Identify your company’s primary and support activities.

This step is obviously important since you must identify all activities in the
procedures of producing products or services, and separate them from each other. It
is essential to know how they can bring value to your customers.

Step 2: Rating the importance of every stage in adding the value on products
or services.
You should prioritize addressing those activities that are the major source of costs or
undertaken less efficiently. Also, the total costs of producing goods or services
should be broken down into each activity.

Step 3: Identify cost drivers.

As a manager, you must know what factors that drive all the cost in order to improve
every process. For instance, direct labor hours are an element that leads to an
increase in manufacturing products costs. There are several technical cost drivers
such as machine hours, the number of product returns, the machine setups required
for production.

tep 4: Identify links between activities.

You must always remember every activity in your business is vital and they support
each other. Therefore, cost reduction in one stage may help reduce costs in
subsequent activities or sometimes it goes the way around. An example for this is
when you simplify and create an innovative design of products, there will be fewer
faulty parts and lower your further service costs.

Step 5: Identify opportunities for improvement.

Once you determine what and where in your procedures should be improved, seek
out a room for a proper solution. You should create a plan or strategy to deal with the
situation. If the wage rates are too high, for instance, you can outsource jobs to
lower-wage countries or utilize the advancement of technology.

Gain competitive advantages through differentiation

Another way of obtaining competitive advantages is to differentiate your business.
This can occur anywhere in your value chain. If your company strives to create
unique value by producing innovative products or providing superior services, you
should follow 3 following steps:

Step 1: Identify activities that create your customer value.

This is the step where you should mainly focus on what activities in the process that
contribute the most to create more value for your customers. For example, Starbucks
tends to innovate its customer experience through continuously improving customer
service so that they can enjoy their cups of coffee with pleasure, not just to drink
normally.

Step 2: Identify differentiation activities to add more value.

There are many strategies that can help you differentiate your products as well as
customer value. You should always consider your customers’ perspective before
making any decision, such as add new product features or offer complementary
products. Also, do not forget to make use of your free resources, which could be a
free guide or a company branded calendar to support your plan.

Step 3: Finding opportunities for differentiation.

It is important to get your differentiation strategy undertaken in an appropriate place,
suitable time with the right targeted customer.

Link your value chain to the value chains of your suppliers and buyers
Your products may be superior and unique to help you gain competitive advantages,
but you must remember to keep your value chain linked to the value chain of
suppliers and buyers. Porter calls that the value system which can relate to all
activities of your business while you operate. If all values meet, it will be easier for
you to deliver satisfying products or services to your customers.

In Summation
Understanding value chain is a great support to direct strategies for a business. By
analyzing value chain and generating the company’s plan strategically, create more
value of its products, services, and customers is created. Also, this can help
companies find out their competitive advantages so that they can improve and
develop to get their customers strongly engaged in the products and services.