What is a value chain?
A value chain is a combination of the systems that a business or organization uses to make money. That is, a value chain is made up of various subsystems that are used to create products or services. This includes the process from start to finish.
Key points to remember
- Michale Porter created a business value chain analysis tool.
- The value chain is the system that a business uses to make money.
- Porter (who is known for Porter’s Five Forces) wrote his book Competitive advantages in 1985, which outlines his method of analyzing value chains.
- According to Porter, competitive advantages come from a company’s processes, such as marketing.
- The five key (primary) activities that generate higher profits include inbound logistics, operations, outbound logistics, marketing and sales, and services.
Michael Porter’s value chain
Given the importance of the value chain, Michael Porter has developed a strategic management tool to analyze a company’s value chain. Porter, known for Porter’s Five Forces, outlined his method of value chain analysis in his 1985 book Competitive advantage.
Porter sought to define a company’s competitive advantage by noting that it stems from a company’s processes, such as marketing and support activities. Porter divides the value chain analysis into five main activities. Then he divides them into four activities that help support the main activities. The main activities of Michael Porter’s value chain are inbound logistics, operations, outbound logistics, marketing and sales, and service. The goal of the five sets of activities is to create value that exceeds the cost of performing that activity, thereby generating a higher profit.
Here are the top five main activities.
Main activities of Porter’s value chain
Inbound logistics include the receipt, warehousing and inventory control of a company’s raw materials. It also covers all relationships with suppliers. For example, for an e-commerce business, the inbound logistics would be the receipt and storage of products from a manufacturer that it plans to sell.
Operations include the procedures for converting raw materials into a finished product or service. This includes modifying all inputs to prepare them as outputs. In the e-commerce example above, this would include adding labels or brands or packaging multiple products into one set to add value to the product.
All activities of distributing a final product to a consumer are considered outbound logistics. This includes product delivery but also includes storage and distribution systems and can be external or internal. For the above e-commerce company, this includes the storage of the products for the shipment and the actual shipment of said products.
Marketing and sales
Strategies to improve visibility and target the right customers, such as advertising, promotion, and pricing, are included in Marketing and Sales. Basically, these are all the activities that help convince a consumer to buy a product or service from a business. Continuing with the example above, an ecommerce business can serve ads on Instagram or build a mailing list for email marketing.
This includes the activities of product maintenance and improving the customer experience: customer service, maintenance, repair, refund and exchange. For an e-commerce business, this could include repairs or replacements, or a warranty.
Porter’s Value Chain Secondary Activities
Now companies can further enhance the primary activities of their value chain with secondary activities. The value chain support activities do just that, they support the core activities. Supportive, or secondary, activity generally plays a role in each primary activity. Such as human resource management, which can play a role in operations, marketing and sales. Here are the four support activities.
Procurement is the acquisition of inputs, or resources, for the business. This is how a company obtains raw materials. It therefore includes research and price negotiation with suppliers and sellers. This is strongly related to the core business of inbound logistics, where an e-commerce business would seek to source materials or goods for resale.
Human Resource Management
Hire and retain employees who will execute the business strategy, as well as assist in the design, marketing and sale of the product. Overall, employee management is useful for all major activities, where employees and efficient hiring are needed for marketing, logistics, and operations, among others.
Infrastructure covers a company’s support systems and the functions that allow it to maintain operations. This includes all accounting, legal and administrative functions. A solid infrastructure is needed for all major functions.
Technology development is used during research and development and may include the design and development of manufacturing techniques and process automation. This includes equipment, hardware, software, procedures and technical knowledge. Overall, a business that strives to reduce technology costs, such as moving from a hardware storage system to the cloud, falls under technology development.
The bottom line
The main activities within Michael Porter’s value chain are used to provide a company with a competitive advantage in any of the five activities so that it has an advantage in the industry in which it operates. In general, the analysis was intended for companies that manufacture goods. But almost any business can use Porter’s value chain analysis even if they don’t have all of the components.