Value chain

A value chain explains how a business transforms inputs, information and effort into an offer for which customers will pay more than the total cost of producing it. It separates the firm into linked activities so managers can see where cost, differentiation and margin arise.

When to use it

• Identify how product or service value is created through the operating system.
• Locate cost, differentiation, coordination problems and opportunities for advantage.

Origins

Harvard Business School professor Michael Porter introduced the value-chain framework as part of his work on competitive advantage. It complements his industry-structure analysis: the competitive-forces framework examines pressures outside the firm, while the value chain examines the activities inside it. Porter’s Competitive Strategy appeared in 1980, and his later work developed the value chain explicitly as a way to connect activity design with cost position and differentiation.

What it is

Step 1 is to map the five primary activities:

Inbound logistics:

Receive, store and move the materials, components or information required by operations. Supplier relationships and input quality strongly influence performance.

Operations:

Transform inputs into the final product or service through production, technical work, maintenance, testing and packaging.

Outbound logistics:

Store, distribute and deliver the completed offer, including activities performed by external logistics partners.

Marketing and sales:

Generate demand, communicate the proposition, manage channels and the sales force, and establish pricing.

Service:

Sustain or increase value after purchase through installation, training, warranties, parts, support and repair.

Four support activities enable the primary flow:

Firm infrastructure:

General management, planning, finance, accounting and legal systems that coordinate and govern the enterprise.

Human-resource management:

Recruit, develop, reward and retain the people required across the chain.

Technology development:

Create and apply product and process technologies that improve cost or differentiation.

Procurement:

Source the goods and services used throughout the business, not only raw materials for production.

Margin is the difference between the value customers pay and the combined cost of the activities. Competitive position cannot be understood from an aggregate company total alone: each activity affects relative cost, differentiation or both.

Links between activities matter as much as the activities themselves. A sales team may acquire a promising customer, only for an inflexible credit-control process to destroy the relationship before revenue is earned. Mapping handoffs and trade-offs prevents one function’s local optimisation from reducing total value.

Developments of the model

The framework is now applied beyond a single firm to supply chains, distribution systems and wider value networks. That broader view helps a company see which participants control access, where profit pools sit and how technology or channel change redistributes bargaining power. The illustration shows a simplified chain for a chemicals manufacturer.

Distributor

Global National Local

distributor distributor distributor

Intermediaries

Importer Reseller Formulators

Users of chemicals

Glass

Paper Soap and detergent Textiles Food additives Bricks Toothpaste manufacture

General public