Value chain analysis

The value chain, also known as value chain analysis, is a concept from business management that was
first described and popularized by Michael Porter in his 1985 best-seller, Competitive Advantage:
Creating and Sustaining Superior Performance.[1]

Michael Porter in 1985 introduced in his book ‘ The Competitive Advantage’ the
concept of the Value Chain. He suggested that activities within the organisation add
value to the service and products that the organisation produces, and all these
activities should be run at optimum level if the organisation is to gain any real
competitive advantage. If they are run efficiently the value obtained should exceed the
costs of running them i.e. customers should return to the organisation and transact
freely and willingly. Michael Porter suggested

that the organisation is split into ‘primary activities’ and ‘support activities’.

Primary activities
Inbound logistics : Refers to goods being obtained from the organisations suppliers
ready to be used for producing the end product.

Operations : The raw materials and goods obtained are manufactured into the final
product. Value is added to the product at this stage as it moves through the production
line.

Outbound logistics : Once the products have been manufactured they are ready to be
distributed to distribution centres, wholesalers, retailers or customers.

Marketing and Sales: Marketing must make sure that the product is targeted towards
the correct customer group. The marketing mix is used to establish an effective
strategy, any competitive advantage is clearly communicated to the target group by
the use of the promotional mix.

Services: After the product/service has been sold what support services does the
organisation have to offer. This may come in the form of after sales training,
guarantees and warranties.

With the above activities, any or a combination of them, maybe essential for the firm
to develop the competitive advantage which Porter talks about in his book.

Support Activities
The support activities assist the primary activities in helping the organisation achieve
its competitive advantage. They include:

Procurement: This department must source raw materials for the organisation and
obtain the best price for doing so. For the price they must obtain the best possible
quality

Technology development: The use of technology to obtain a competitive advantage

within the organisation. This is very important in today’s technological driven
environment. Technology can be used in production to reduce cost thus add value, or
in research and development to develop new products, or via the use of the internet so
customers have access to online facilities.

Human resource management: The organisation will have to recruit, train and

develop the correct people for the organisation if they are to succeed in their
objectives. Staff will have to be motivated and paid the ‘market rate’ if they are to
stay with the organisation and add value to it over their duration of employment.
Within the service sector eg airlines it is the ‘staff’ who may offer the competitive
advantage that is needed within the field.

Firm infrastructure: Every organisations needs to ensure that their finances, legal
structure and management structure works efficiently and helps drive the organisation
forward.

As you can see the value chain encompasses the whole organisation and looks at how
primary and support activities can work together effectively and efficiently to help
gain the organisation a superior competitive advantage.

Concept
[edit]Firm Level
A value chain is a chain of activities for a firm operating in a specific industry. The business unit is the
appropriate level for construction of a value chain, not the divisional level or corporate level. Products
pass through all activities of the chain in order, and at each activity the product gains some value. The
chain of activities gives the products more added value than the sum of added values of all activities. It is
important not to mix the concept of the value chain with the costs occurring throughout the activities. A
diamond cutter can be used as an example of the difference. 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.
[edit]Activities

The value chain categorizes the generic value-adding activities of an organization. The "primary activities"
include: inbound logistics, operations (production), outbound logistics, marketing and sales (demand), and
services (maintenance). The "support activities" include: administrative infrastructure management,
human resource management, technology (R&D), and procurement. The costs and value driversare
identified for each value activity.

[edit]Industry Level
An industry value chain is a physical representation of the various processes that are involved in
producing goods (and services), starting with raw materials and ending with the delivered product (also
known as the supply chain). It is based on the notion of value-added at the link (read: stage of production)
level. The sum total of link-level value-added yields total value. The French Physiocrat's Tableau
économique is one of the earliest examples of a value chain. Wasilly Leontief's Input-Output tables,
published in the 1950's, provide estimates of the relative importance of each individual link in industry-
level value-chains for the U.S. economy.

Michael Porter published the Value Chain Analysis in 1985 as a response to criticism that his Five
Forces framework lacked an implementation methodology that bridged the gap between internal
capabilities and opportunities in the competitive landscape. This framework focused on industry
attractiveness as a determinant of the profit potential of all companies within that particular industry.
However, significant differences in performance exist between companies operating within the same
industry that can be explained either by the company's participation in a successful strategic group or
by a firm's specific competitive advantages.
 
Value Chain Analysis helped identify a firm's core competencies and distinguish those activities that
drive competitive advantage. The cost structure of an organisation can be subdivided into separate
processes or functions assuming that the cost drivers for each of these activities behave differently.
Porter's strength was to condense this activity based cost analysis into a generic template consisting
of five primary activities and four support activities. The nine activity groups are:
 
Primary activities:
1. inbound logistics: materials handling, warehousing, inventory control, transportation;
2. operations: machine operating, assembly, packaging, testing and maintenance;
3. outbound logistics: order processing, warehousing, transportation and distribution;
4. marketing and sales: advertising, promotion, selling, pricing, channel management;
5. service: installation, servicing, spare part management;
 
Support activities:
6. firm infrastructure: general management, planning, finance, legal, investor relations;
7. human resource management: recruitment, education, promotion, reward systems;
8. technology development: research & development, IT, product and
    process development;
9. procurement: purchasing raw materials, lease properties, supplier contract negotiations.
 
By subdividing an organisation into its key processes or functions, Porter was able to link classical
accounting to strategic capabilities by using value as a core concept, i.e. the ways a firm can best
position itself against its competitors given its relative cost structure, how the composition of the value
chain allows the firm to compete on price, or how this composition allows the firm to differentiate its
products to specific customer segments.
pros:

Value Chain Analysis provides a generic framework to analyse both the behaviour of costs as
well as the existing and potential sources of differentiation.
 

Porter emphasised the importance of (re)grouping functions into activities to produce,

market, deliver and support products, to think about relationships between activities and to
link the value chain to the understanding of an organisation's competitive position.
 

The value chain made clear that an organisation is multifaceted and that its underlying
activities need to be analysed to understand its overall competitive position. An
 organisation's strengths and weaknesses can only be identified in relation to the profiles of its
direct competitors. Competitive advantage is derived from an integrated set of decisions on
these key activities.
 

The Value Chain model was intended as a quantitative analysis. It can also be used as a
quick scan to describe the strengths and weaknesses of an organisation in qualitative terms.
 

With the Value Chain Analysis, Porter tried to overcome the limitations of portfolio planning in
multidivisional organisations. The concept of Strategic Business Units stated that businesses
within a conglomerate should act independently while headquarters should be responsible
only for budgetary decisions to be based on a business unit's position in the overall portfolio.
Porter used his Value Chain Analysis to identify synergies or shared activities between
Strategic Business Units and to provide a tool to focus on the whole rather than on the parts.
 

cons:

The quantitative analysis is time consuming since it often requires recalibrating the
accounting system to allocate costs to individual activities. Porter provided qualitative
guidance for a quantitative exercise. His analysis began with identifying the relevant
activities that lead to competitive differences and are significant enough to influence the
organisation's overall cost base.
 

The Value Chain Analysis should be accompanied with a customer segmentation analysis to
mix the internal and external view. A feature or product provides the firm with a
differentiating competitive advantage only if customers are willing to pay for it. Customer
value chains need to be analysed to determine where value is created.
 

The Value Chain is used to analyse a firm's position in relation to its direct competitors with
the assumption that rivalry drives profitability. This excludes other assumptions such as
customer bonding in Alexander Hax's delta model.
 

The Value Chain Analysis was developed to analyse physical assets in product environments.
Other authors amended the model to accommodate intangible assets and service
organisations.