What Is a Value Chain?
A value chain is a combination of the systems a company 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.
- Michale Porter created a tool for analyzing a company's value chain.
- The value chain is the systems that a company uses to make money.
- Porter (who is known for Porter’s five forces) wrote his book Competitive Advantages in 1985, which laid out his method of analyzing value chains.
- According to Porter, competitive advantages come from the processes a company has, 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 developed a strategic management tool for analyzing a company’s value chain. Porter, known for Porter’s five forces, laid out his method of analyzing value chains in his 1985 book Competitive Advantage.
Porter sought to define a company’s competitive advantage noting that it stems from a company’s processes, such as marketing and supporting activities. Porter breaks value chain analysis into five primary activities. Then, he further breaks those down into four activities that help support primary activities. The primary 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 conducting that activity, therefore generating a higher profit.
Here are the five key primary activities.
Porter’s Value Chain Primary Activities
Inbound logistics include the receiving, warehousing, and inventory control of a company's raw materials. This also covers all relationships with suppliers. For example, for an e-commerce company, inbound logistics would be the receiving and storing of products from a manufacturer that it plans to sell.
Operations include procedures for converting raw materials into a finished product or service. This includes changing all inputs to ready them as outputs. In the above e-commerce example, this would include adding labels or branding or packaging several products as a bundle to add value to the product.
All activities to distribute a final product to a consumer are considered outbound logistics. This includes delivery of the product but also includes storage and distribution systems and can be external or internal. For the e-commerce company above, this includes storing products for shipping and the actual shipping of said products.
Marketing and Sales
Strategies to enhance visibility and target appropriate customers—such as advertising, promotion, and pricing—are included in marketing and sales. Basically, these is all activities that help convince a consumer to purchase a company’s product or service. Continuing with the above example, an e-commerce company may run ads on Instagram or build an email list for email marketing.
This includes activities to maintain products and enhance consumer experience—customer service, maintenance, repair, refund, and exchange. For an e-commerce company, this could include repairs or replacements, or a warranty.
Porter's Value Chain Secondary Activities
Now, companies can further improve the primary activities of their value chain with secondary activities. Value chain support activities do just that, they support the primary activities. The support, 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 supporting activities.
Procurement is the acquisition of inputs, or resources, for the firm. This is how a company obtains raw materials, thus, it includes finding and negotiating prices with suppliers and vendors. This relates heavily to the inbound logistics primary activity, where an e-commerce company would look to procure materials or goods for resale.
Human Resource Management
Hiring and retaining employees who will fulfill business strategy, as well as help design, market, and sell the product. Overall, managing employees is useful for all primary activities, where employees and effective 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 necessary for all primary functions.
Technological development is used during research and development and can include designing and developing manufacturing techniques and automating processes. This includes equipment, hardware, software, procedures, and technical knowledge. Overall, a business working to reduce technology costs, such as shifting from a hardware storage system to the cloud, is technological development.
The Bottom Line
The primary activities within Michael Porter's value chain are used to provide a company with a competitive advantage in any one of the five activities so it has an advantage in the industry in which it operates. In general, the analysis was meant for companies that manufacture goods. But almost any company can use the value chain analysis laid out by Porter even if they don’t have all the components.