A value chain represents all the activities and processes involved in creating a product or performing a service. As such, it encompasses every stage of the product's or service's lifecycle, from design to production and distribution.
In seeking higher profit margins or a competitive advantage, companies can conduct a value-chain analysis to identify each step (or link) in the chain and look for ways to improve it.
- A value chain represents every step that's involved in creating a product or delivering a service, from start to finish.
- A company's value chain can be divided into primary activities and secondary (or support) activities.
- Value chain analysis is the process of examining each of those activities in terms of what they cost, the value they deliver, and how they might be optimized in keeping with the company's competitive strategy. It also looks at how the various activities interrelate.
- Companies can compete on the basis of delivering a unique or superior product or one that is attractive primarily due to a lower price.
What Is Value Chain Analysis?
Michael E. Porter, a Harvard Business School professor, is credited with introducing the concept of a value chain in his 1985 book The Competitive Advantage: Creating and Sustaining Superior Performance.
"The value chain disaggregates a firm into its strategically relevant activities in order to understand the behavior of costs and the existing and potential sources of differentiation," he wrote. "A firm gains competitive advantage by performing these strategically important activities more cheaply or better than its competitors."
Value chain analysis is the process of identifying each of these activities, determining their costs and the value they deliver, and then looking for ways to optimize them in keeping with the company's overall strategy.
As the Harvard Business School puts it, this process "forces managers to consider and see each activity not just as a cost, but as a step that has to add some increment of value to the finished product or service."
Michael Porter's framework for value chain analysis groups activities into two broad categories: primary activities and secondary (or support) activities.
An Example of Value Chain Activities
Consider an asset management firm. Its value chain might consist of the following kinds of activities:
- Investing: The investment team (portfolio managers, analysts) is tasked with making the investment decisions.
- Operations and trading: The operations and trading teams are tasked with ensuring the investments are in line with the clients' goals and the trades are made at the best execution price.
- Marketing and sales: Responsible for procuring additional clients for the firm.
- Service (client relationship management): Responsible for providing all the touch points to current clients.
Secondary (or support) activities
- Technology: To make the operation run smoothly,
- Human resources: To find and retain talent for the firm.
- Other infrastructure: This includes the lawyers and risk managers who ensure that the firm is operating within the regulations established by the SEC.
That may be only a partial list. In Porter's words, "Everything a firm does should be captured in a primary or support activity."
How to Use Value Chain Analysis
In examining its value chain, a business needs to consider its value proposition, or what sets it apart from its competitors. Value chain analysis may be conducted with the goal of improving profits by creating a product or service that is so superior that customers are willing to pay more for it, or one that undercuts the competition by delivering a product or service of respectable quality at a lower price.
Improving a value chain simply for the sake of improvement should not be the end goal. Instead, a company should decide why it wants to improve its value chain in the context of its desired competitive advantage.
Two common competitive advantage strategies include low-cost provider and specialization/differentiation of product or service.
- Low-cost provider. Here the value chain analysis will focus largely on costs and how a company can reduce those costs to give itself a competitive advantage in the marketplace.
- Specialization/differentiation. In this strategy, the analysis will focus on the activities that create a unique product or differentiation in service, which may, in turn, allow it to charge a higher price.
Let's go back to our asset management example. If the firm wants to pursue a strategy of differentiation by delivering steady, top quartile returns on clients' investments, it will focus on the investment team, operations, and traders, along with the related support activities. If its goal is to differentiate itself through stellar service, it will focus its efforts on client relationship management.
Who Is Michael Porter?
Michael Porter is the Bishop William Lawrence University Professor at Harvard Business School and the director of the school's Institute for Strategy and Competitiveness. His 19 books include The Competitive Advantage: Creating and Sustaining Superior Performance and Competitive Strategy: Techniques for Analyzing Industries and Competitors.
What Is Competitive Advantage?
Competitive advantage is what gives one company an edge over others in the marketplace. It can take the form of a comparative advantage, where the company is able to produce a good or service more efficiently than its competitors, allowing it to sell at a lower price and/or enjoy a higher profit margin; or it can be a differential advantage, where a company's product or service is perceived to differ from its competitors' in a way that is superior, allowing it to charge a higher price.
What Is a Global Value Chain?
A global value chain (GVC) refers to a value chain in which the activities and processes involved in bringing a product to market occur in more than one country.
The Bottom Line
Value chain analysis can help companies identify ways to create and deliver products and services that, by virtue of their superior quality or lower cost, provide a competitive advantage in the marketplace. Conducting a value chain analysis can focus management on which activities add the most value, in keeping with the company's overall competitive strategy, and help drive future products and services. Another benefit is that the analysis can draw attention to support activities, which are sometimes overlooked in adding value.