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What is a 'Value Chain'

A value chain is a high-level model developed by Michael Porter used to describe the process by which businesses receive raw materials, add value to the raw materials through various processes to create a finished product, and then sell that end product to customers. Companies conduct value-chain analysis by looking at every production step required to create a product and identifying ways to increase the efficiency of the chain. The overall goal is to deliver maximum value for the least possible total cost and create a competitive advantage.

BREAKING DOWN 'Value Chain'

A value chain is a company model that breaks down the flow of production activities into five categories. Each one of these categories is an opportunity for a company to maximize efficiency and create a competitive advantage. The aim of the value chain is to increase profits by creating value at each of the five product touchpoints so the value exceeds the cost associated with the product.

Primary Activities of the Value Chain

All five primary activities are essential in adding value and creating a competitive advantage. The first activity in the value chain is inbound logistics, which includes all receiving, warehousing and inventory management of raw materials ready for production. The second activity is operations and encompasses all efforts needed to convert raw materials into a finished product or service.

Outbound logistics is the third activity in the value chain and occurs after all operations are completed and the end product is ready for the customer. Activities required to deliver a product to the end user are considered part of outbound logistics. Marketing and sales are the fourth part of the value chain and include all strategies used to get potential customers to purchase a product, such as channel selection, advertising and pricing. Service is the fifth and final step in a company's value chain and describes all activities that create better consumer experiences, such as customer service and repair services.

Companies can harness a competitive advantage at any one of the five activities in the value chain. Creating outbound logistics that are highly efficient, for example, cuts down on a company's shipping costs and allows it to either realize more profits or pass the savings through to the consumer, lowering the price point.

Support Activities of the Value Chain

Support activities facilitate the efficiency of the primary activities in a value chain. The four support activities are procurement, technological development, human resource management and company infrastructure. Increasing the efficiency of any of the four support activities increases the benefit to at least one of the five primary activities. These support activities are normally denoted as overhead costs on a company's income statement.

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RELATED FAQS
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    Understand how an investor can use value chain analysis to evaluate an investment decision. Learn what activities add value ... Read Answer >>
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    Understand what makes up a company's value chain and the point of a value chain. Learn how a strong value chain management ... Read Answer >>
  3. What is the difference between a value chain and a supply chain?

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  4. What are the primary activities of Michael Porter's value chain?

    Understand the primary activities of Michael Porter's value chain, and learn how a company can optimize those activities ... Read Answer >>
  5. What are some advantages and disadvantages of value chain analysis?

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