A Value Chain is a chain of activities that a firm operating in a specific industry performs in order to deliver a valuable product or service for the market. The concept comes from business management and was first described and popularized by Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and Sustaining Superior Performance. The diagram below illustrates the typical construct of an organization’s Value Chain.
The Activities of the Value Chain
- Primary activities (line functions)
- Inbound Logistics. Includes receiving, storing, inventory control, transportation planning.
- Operations. Includes machining, packaging, assembly, equipment maintenance, testing and all other value-creating activities that transform the inputs into the final product.
- Outbound Logistics. The activities required to get the finished product at the customers: warehousing, order fulfillment, transportation, distribution management.
- Marketing and Sales. The activities associated with getting buyers to purchase the product, including: channel selection, advertising, promotion, selling, pricing, retail management, etc.
- Service. The activities that maintain and enhance the product’s value, including: customer support, repair services, installation, training, spare parts management, upgrading, etc.
- Support activities (Staff functions, overhead)
- Procurement. Procurement of raw materials, servicing, spare parts, buildings, machines, etc.
- Technology Development. Includes technology development to support the value chain activities. Such as: Research and Development, Process automation, design, redesign.
- Human Resource Management. The activities associated with recruiting, development (education), retention and compensation of employees and managers.
- Firm Infrastructure. Includes general management, planning management, legal, finance, accounting, public affairs, quality management, etc.
This business framework presentation, developed by Learn PPT, does a good job in explaining how to conduct thorough Value Chain analysis.
Creating a cost advantage based on the value chain
A firm may create a cost advantage:
- by reducing the cost of individual value chain activities, or
- by reconfiguring the value chain.
Note that a cost advantage can be created by reducing the costs of the primary activities, but also by reducing the costs of the support activities. Recently there have been many companies that achieved a cost advantage by the clever use of Information Technology.
Once the value chain has been defined, a cost analysis can be performed by assigning costs to the value chain activities. Porter identified 10 cost drivers related to value chain activities:
- Economies of scale.
- Capacity utilization.
- Linkages among activities.
- Interrelationships among business units.
- Degree of vertical integration.
- Timing of market entry.
- Firm’s policy of cost or differentiation.
- Geographic location.
- Institutional factors (regulation, union activity, taxes, etc.).
A firm develops a cost advantage by controlling these drivers better than its competitors do. A cost advantage also can be pursued by “Reconfiguring” the value chain. “Reconfiguration” means structural changes such as: a new production process, new distribution channels, or a different sales approach.
The appropriate level for constructing a value chain is the business unit, (not division or corporate level). Products pass through activities of a chain in order, and at each activity the product gains some value. Chain of activities gives the product more added value than sum of the independent activities’ values.
The activity of a diamond cutter can illustrate the difference between cost and the value chain. The cutting activity may have a low cost, but the activity adds much of the value to the end product, since a rough diamond is significantly less valuable than a cut diamond. Typically, the described value chain and the documentation of processes, assessment and auditing of adherence to the process routines are at the core of the quality certification of the business, e.g. ISO 9001.
Normally, the Value Chain of a company is connected to other Value Chains and is part of a larger Value Chain. Developing a competitive advantage also depends on how efficiently you can analyze and manage the entire Value Chain. This idea is called: Supply Chain Management. Some people argue that network is actually a better word to describe the physical form of Value Chains: Value Networks.
Source: Michael E. Porter – Competitive AdvantageBusiness frameworks like Value Chain are invaluable to evaluating and analyzing various business problems. You can download business frameworks developed by management consultants and other business professionals at Flevy here.