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What is '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 the finished 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 segments 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 touchpoints so that total value exceeds the total costs 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, which encompasses all efforts to convert raw materials into a finished product.

Outbound logistics is the third activity in the value chain and occurs after all operations are completed and the 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 to enhance the visibility of the product, satisfy consumer needs with the product, and facilitate the sale of the product.  Activities include 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, refund and exchange programs, and warranty 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, reduces a company's shipping costs and allows it to either realize more profits or pass the savings to the consumer by way of lower prices.

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 (HR) 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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