What Are Value Chains, and Who Uses Them?
A value chain includes the activities that take place within a company in order to deliver a valuable product or service to their market. Each stage of the value chain adds more value. The value chain provides a tool to visualize a firm's productivity by identifying the thousands of discrete activities involved. "The value chain provides a rigorous way to understand the sources of buyer value that will command a premium price, and why one product or service substitutes for another," says Porter.
Value chain analysis is used by business analysts, project managers, and administrators to evaluate which activities provide the greatest opportunities to maximize profitability and achieve a competitive advantage. It is quite common for C-level executives to face the challenge of “how do we innovate?” Therefore, global organizations such as Procter & Gamble, Intuit, Shell, Nokia, Apple, and Samsung have adopted value chain analysis to help implement winning strategies that aid them in soaring past the competition.
Businesses across all industries - technology, manufacturing, healthcare, government, finance, retail, etc. - have a value chain, whether they acknowledge and analyze it or not. Even a small ice cream shop displays the elements of a value chain from onboarding cream, sugar, and cups all the way through hiring, sending out coupons, churning the cream, and ultimately putting the dripping cone in the customer's hand. Effective management of this value chain provides opportunities for cost containment and differentiation that create avenues for enhanced customer and brand value. Therefore, it becomes increasingly important to implement value chain management, analysis, and strategies to produce or maintain a competitive advantage.
Value Chain Definitions
- Value Chain - The activities that take place within a company in order to deliver a valuable product or service to their market.
- Value Chain Analysis – A tool for analyzing activities to find those that are most valuable.
- Porter’s Value Chain – A framework, created by Michael Porter, that helps identify specific activities that contribute value and create competitive advantage.
- Value Chain Management – The process of identifying and organizing the activities that add value in the production of goods and services in an effort to increase collaboration, increase competitive advantage, and improve customer satisfaction.
Porter’s Value Chain Model
Porter's value chain model presents nine elements (five primary activities and four support activities). It provides a useful tool to analyze the relationship of cost to build versus the price a consumer is willing to pay. Because the value chain examines what activities are most beneficial, it is also used to find opportunities, innovations, or practices that set the firm's offering apart from its competition.
There are five functional areas identified as "primary activities." These functions are shown in a logically sequenced horizontal line that includes:
First, identify the primary and supporting activities and the tasks within each activity. Next, classify valuable and wasteful activities. Use this information to guide change to maximize value and eliminate waste.
Inbound Logistics: These are the activities that receive, store, and handle materials. They include warehousing, inventory, scheduling, and vendor returns.
Operations: This area represents all the activities to build or develop the end product including assembly, testing, labeling, packaging, and overall facility operations.
Outbound Logistics: Once developed, it’s time to distribute the product. Identify activities such as order processing, scheduling, warehousing finished goods, and delivery.
Marketing and Sales: Activities include branding, advertising, promotion, sales force management, pricing, and quoting.
Service: Maintenance of the product, installation, repair, and training are all part of this function.
There are also four “support activity” centers that support these five primary functions. They are found on the model in a vertical "umbrella" over the primary functions because these operations get distributed throughout the entire enterprise.
Firm Infrastructure: These are the activities that are interwoven throughout the entire business structure including finance, legal, quality, government affairs, general management, and accounting.
Human Resources Management: HR is responsible for providing methods of hiring, training, compensation, and motivation for personnel in all areas of the business.
Technology Development: This area is more than research and development. It includes uses of technology for overall business support such as phones and plans, office automation, order processing methods, and procedures.
Procurement: This activity includes purchasing raw materials and supplies, as well as vendor qualification, building or leasing, info system development, and fleet management.
These are the discrete functions and activities that make up Porter's generic value chain model. You can use this model to design or re-design an organizational structure, as well as to develop a management and analysis strategy to identify both cost advantages and differentiation opportunities.
How to Apply Value Chain Analysis
It’s beneficial to utilize a case study model when researching the primary and secondary activities to find areas for cost advantages. However, when analyzing for cost opportunities, Porter asserts that lowest-cost in the marketplace may not always be the best method for developing customer value. Instead, he advocates identifying those tasks, policies, and product improvements that make it "stand out" from the competition. A purchaser may use these key areas of differentiation when choosing one product over the competition.
The airline industry represents a good example of differentiation. Many airlines operate under similar circumstances and share similar cost structures and routes. Methods of differentiation can include the overt elements (lowest-price or on-time record), but smaller areas (such as boarding procedures, carry-on policies, airline miles, and even social media buzz) can bring large differentiation results and drive customer loyalty. Eastern Airlines provides a case study illustrating how the ability to put people first creates a solid marketing position. Applying elements found in effective case study analysis is important to identify and apply the opportunities that increase a product or service's perceived value to the customer.
The five competitive forces that make up an entire "value system" are key to analyzing differentiation. As Porter notes, "Gaining and sustaining competitive advantage depends upon understanding not only a firm's value chain, but how the firm fits in the overall value system." As the term "chain" implies, there are fundamental linkages and areas of interdependence to support each of the discrete individual activities within the chain. The value chain is part of an overall value system that encompasses both the supply chain (at the front end of inbound activities) and the buyer's chain (at the end). All focus on buyer satisfaction and loyalty that is measured by repeat sales and brand success.
Sean Martin, Marketing Manager at Directive Consulting, has applied value chain analysis to identify the goals that will grow business in 2017. “We’ve doubled the size of our company and want to keep focus. This means a lot of analysis of our different systems. While this may seem like tedious tactics, it’s been great for our reorganization and to re-focus. We’ve identified the five goals that will directly grow Directive and the three metrics that we’ll track going forward. If it isn’t directly impacting our growth, we don’t even bother with it,” he says.
Disadvantages of Using a Value Chain
When implemented properly, a value chain is a useful tool and an informative way to examine and analyze the thousands of discrete activities performed within your organization. But a thorough examination of all the activities and resources that make up a value chain are time-consuming. Additionally, it is generally recommended to involve numerous stakeholders in value chain development, which can be difficult.
Porter's value chain is a generic model and not a rigid, prescriptive framework. Porter himself states that planning for flexibility in implementation will generate a more useful value chain. While all elements of the value chain are present in all industries, not all primary or support functions are created equal, and it may be difficult to find the required information. For example, some industries (such as distribution) may have greater demand on inbound and outbound activities. By contrast, a copier manufacturer may put more emphasis on service responsibilities such as installation, training, and service after the sale. The point is that analysis of a firm's value chain involves integrated thinking, observation, and effective data gathering in order to identify areas where costs can be mitigated or elements of competitive differentiation can be deployed.
Another challenge in rigidly adhering to the Porter model is that practitioners may view each area of activity as independent and absolute in their functions. To address this, Porter advocates a cross-functional approach that "builds bridges" to the primary functions and the support functions in the chain. He also notes that some of the discrete activities named in the original model can be moved around to find areas of differentiation or cost control. For example, some industries benefit more if Marketing and Sales handle order processing, rather than Outbound Logistics.
Industry Usage and Global Value Chains
Because of its generic makeup, the value chain model is a scalable system that can expand across business units. Large industry sectors (such as software development) have addressed their own unique needs by scaling the generic value chain. International policy applications are also using value chains: these global chains recognize new integrated partnerships of private and public sector enterprises working with governments and multinational coalitions. The value chain has even found humanitarian applications for developing countries that support micro-industries in Africa and Aquafeed in Egypt.
Value Chain Templates
Porter's book on competitive advantage is still the best resource for a complete understanding of value chain implementation, management, and analysis, but many other best practice solutions are emerging for specific industry applications. Since there could be thousands (or even millions) of discrete activities to follow and analyze in a value chain, specialized templates and software solutions are becoming widely available to manage these activities. These tools are also valuable additions for an endeavor of any size to maintain a constant and ongoing process of value change management and analysis.
Goals of Value Chain Analysis
When analyzing a value chain, look for areas of optimization and coordination to identify key short- and medium-term solutions. Optimization addresses elements that make systems work better - at a lower cost or higher quality. A coffee roasting plant may derive market benefits from sourcing their product from organic farms, and then task Marketing and Sales with positioning or branding that differentiates the product from competitors. Through coordination, the tasks are then put in place to enact the change and communicate new or increased value to the customer.
Benefits of Value Chains
The goal of a value chain strategy is to maintain or achieve a competitive advantage. This can be accomplished through a purposefully structured process; however, it is the development of effective cross-functional relationships within the enterprise that allow for growth and innovation. These areas of differentiation, achieved through optimization and coordination, can be the catalysts that bring real results in cost reduction, increased customer value, and market dominance. An effective value chain analysis will help you:
- Identify activities that are useful vs. activities that waste time.
- Improve brand reputation.
- Respond to weaknesses, opportunities, and threats quickly.
- Reduce costs.
- Increase productivity.
- Improve customer satisfaction.
- Streamline service/product delivery.
- Differentiate from the competition and achieve competitive advantage.
- Identify your profit margin. (Identify the value that you deliver to the customer and then subtract the costs associated with creating that value to get your profit margin.)
The Future of Value Chain Analysis
It is becoming increasingly difficult to manage value chains using predefined templates and simple software solutions. Technology has led to significant changes in consumer behavior, which impacts activities in the value chain. In addition, large, global organizations tend to outsource activities locally and globally, which adds complexity. This may require some industries to rethink their approach to value chains and leverage more sophisticated, big data software to analyze the data. For example, the retail industry must adapt or face possible extinction due to technology. Read more about a structured approach to a retail value chain to understand the value added from production to consumption.
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