Value Chain

The value chain model was proposed by Michael Porter in his book entitled Competitive Advantage published in 1980. The chain shows how value is created within a business. It is often used alongside Porter’s “competitive forces”, another framework which is used to assess value creation and which examines external forces influencing a business.

Businesses create value. They do so by taking materials or ideas and making them into something for which they can charge a price that covers the cost of conversion. The value chain is the way that materials enter the company and move through it, increasing in value as they do so.

​

Michael Porter identified five activities in the value chain within a company.

​

1. Inbound logistics: These are the products or materials that enter the company and which will be stored and processed in order to create the finished product. Relationships with suppliers are important as they are the source of materials bought by the company.

2. Operations: These are the processes which are used to create the products and services. It includes the technical department, maintenance, production, testing and packaging.

3. Outbound logistics: This is the part of the company that deals with the finished product and moving it to customers. It involves warehousing and transportation including any logistics that are outsourced.

4. Marketing and sales: Products must be sold and for this their needs to be a process for generating interest and executing sales. This part of the value chain covers the internal and external development of promotions, the management of the sales force, and the pricing strategy.

5. Service: The product is supported by a warranty and a service department. This includes the supply of spare parts, product installation, training, repair services etc. 

These five primary activities require support. Porter identified four support activities within companies:

​

1. Infrastructure: These are departments responsible for planning, accounting, legal, and general management. They are the arteries of the business that enable it to operate.

2. Human resources: This department recruits, trains and manages the people within the business.

3. Technology development: This team develops technologies that ensure the product has a competitive advantage.

4. Procurement: This is the department that sources materials and services that are required in the production of the product.

The value chain model provides a structure for examining the different parts of the company to see which successfully adds value and which does not. In making this examination, care should be taken to note the links between different activities. Broken links destroy value. For example, a sales team could work hard to bring a new customer on board and the accounts team could be over zealous in applying a credit control rating which frustrates the new customer and causes them to leave before any business is carried out.

Both the primary and support activities add value to the business. Inbound logistics, operations and service are activities that are centred on the product. Marketing/sales and outbound logistics are activities are outward facing and relate to the market.

The difference between the total costs of producing the product and the revenue of the company is its margin. This margin is a measure of the value that has been added and is reflected as a return on the investment.

Porter argues that the competitive position of the company cannot be understood by looking at the firm as a whole. It is necessary to examine each of the primary and support activities to see how they contribute to the firm’s relative cost position and create any basis for differentiation.

The value chain framework has become a popular tool within management. It has been extended beyond individual businesses and applied to whole supply chains and distribution networks. The concept of understanding a supply chain allows a business to see where the profit is made and who controls the chain.

Some things to think about:

• A business is a conveyor belts that takes raw materials and labour and converts it into an offer with added value. Every department plays a role in this process and contributes to the value. Where is the value created in your company? How strong are the links between the different departments? Could they be improved in any way which would add value?

  
  

• In addition to the value chain within your business, do you know the value chain in your market? What is changing in the way products get from you to the final customer? How are you responding to this change? Who is making the money? How could your business make more money within this value chain?