Business and consumer needs, the industry value chain and competitive forces: formula sheet

Key formulas

Value created at a stage

Value added = Value to the customer − Cost of performing the stage

A conceptual rule, not a numeric formula. A stage that costs more than the value it gives is a candidate for redesign, outsourcing or removal.

Insurer value chain (primary activities)

Product design → Distribution → Underwriting → Administration → Claims → Investment

Learn this order, but state that the exact stages and names vary by insurer and by line of business.

Support activities

IT, HR, finance, actuarial, risk and compliance, capital management

These cut across all primary stages. Do not draw them as a separate step in the sequence.

Combined ratio (general insurance)

Combined ratio = (Claims + Expenses) ÷ Premium

Below 100% means an underwriting profit before investment income. Useful to show where value is gained or lost.

Five forces list

Industry profitability depends on: rivalry + new entrants + substitutes + buyer power + supplier power

No numerical formula. Learn the five names and give a reason for each force.

Entry barriers (typical)

Scale economies, capital needs, brand, distribution access, regulation and licensing, switching costs

Use these to judge the threat of new entrants. High barriers mean a weaker threat.

Buyer power drivers

Few large buyers, low switching costs, price sensitivity, easy comparison, standard products

These raise buyer power. Online comparison sites raise it for simple products such as motor or term cover.

Supplier power drivers

Few suppliers, specialised input, high switching cost, supplier can integrate forward

A bank that distributes most of an insurer's policies has strong supplier power.

Cost leadership

Lowest cost in the industry → price at or below rivals, or higher margin

Needs scale, tight expense control and efficient processes. Customers must still see the product as acceptable.

Differentiation

Unique value to customers → premium price that exceeds the extra cost of being unique

Works only if the premium is greater than the added cost, and customers value the difference.

Focus

Narrow segment + (cost focus or differentiation focus)

Chosen segment must be large enough to be profitable and be poorly served by broad competitors.

Test of sustainable advantage

Valuable + rare + hard to imitate (+ organised to exploit)

This is the resource-based view. Use it to judge whether an advantage will last.

Quick revision

• Consumer needs include protection, saving, income in retirement, credit and convenience; business needs include managing risk, funding and cash flow.
• Stakeholders can have conflicting objectives, such as shareholders wanting returns and policyholders wanting security.
• The value chain breaks the industry into stages, from product design through to claims and servicing, and shows where value is created.
• Ask at each stage who performs it, what it costs and whether the firm should do it in-house or outsource.
• Distribution can be direct or through intermediaries such as agents, brokers and banks, and each has cost and control trade-offs.
• Porter's five forces are threat of new entrants, threat of substitutes, bargaining power of buyers, bargaining power of suppliers and rivalry among existing firms.
• Strong forces push industry profit down; weak forces let firms earn more.
• Always tie each force to evidence from the case, not just the label.
• Sources of advantage include low cost, differentiation and focus on a niche.
• An advantage is only useful if customers value it and competitors cannot easily copy it.
• In written answers, analyse, reach a judgement and recommend an action.

Common mistakes

• Listing products without linking them to a need. Fix: Write the need first, then the product, then the feature that meets the need.
• Treating savings and protection as the same need. Fix: Split the benefit into its protection part and its savings part and name each.
• Listing stakeholders without stating their objectives. Fix: Always write the stakeholder and a specific objective together, then link it to the scenario.
• Treating shareholders and policyholders as always opposed. Fix: State both sides. Fair treatment and solvency support long-term profit and customer trust.
• Copying Porter's manufacturing labels such as inbound logistics and outbound logistics onto an insurer. Fix: Keep the logic but rename the stages in insurance terms. Say you are adapting the model.
• Listing the stages with no comment on value. Fix: For every stage, write how value is added and how it is lost. That is what earns analysis marks.
• Saying a broker works for the insurer. Fix: Remember that who pays is not the same as who is represented. A tied agent represents the insurer. A broker represents the customer.
• Listing channels without comparing them. Fix: Always compare on cost, control and reach, and tie each point to the product or customer in the question.
• Listing the five forces with no application to the case. Fix: Add a named player or fact from the case to every force, and say whether it makes the force stronger or weaker.
• Mixing up buyers and suppliers in financial services. Fix: Buyers are those who purchase the firm's product, including corporate clients. Suppliers provide inputs such as capital, reinsurance, distribution, technology and talent. Say which role each party plays.

Exam tips

• Always start with the customer and the need before naming a product.
• Cover both individuals and businesses when the question is general.
• Add one non-financial need, such as trust or simplicity, to pick up extra marks.
• In case studies, quote facts from the scenario such as age, dependants or business size.
• Show both the customer view and the provider view in longer answers.
• Always tie each stakeholder's objective to the scenario given. Generic lists earn few marks.
• For conflict questions, name a pair of stakeholders and give the reason, not just the word conflict.
• Include the regulator, as it is easy to forget and often carries marks.