Value Chain

The value chain, also known as value chain analysis, is a concept from business management that was first described and popularized by Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and Sustaining Superior Performance.
A value chain is a chain of activities. Products pass through all activities of the chain in order and at each activity the product gains some value. The chain of activities gives the products more added value than the sum of added values of all activities. It is important not to mix the concept of the value chain with the costs occurring throughout the activities. A diamond cutter can be used as an example of the difference. The cutting activity may have a low cost, but the activity adds much of the value to the end product, since a rough diamond is significantly less valuable than a cut diamond.
The value chain categorizes the generic value-adding activities of an organization. The "primary activities" include: inbound logistics, operations (production), outbound logistics, marketing and sales (demand), and services (maintenance). The "support activities" include: administrative infrastructure management, human resource management, technology (R&D), and procurement. The costs and value drivers are identified for each value activity. The value chain framework quickly made its way to the forefront of management thought as a powerful analysis tool for strategic planning. The simpler concept of value streams, a cross-functional process which was developed over the next decade,[1] had some success in the early 1990s[2].

The value-chain concept has been extended beyond individual organizations. It can apply to whole supply chains and distribution networks. The delivery of a mix of products and services to the end customer will mobilize different economic factors, each managing its own value chain. The industry wide synchronized interactions of those local value chains create an extended value chain, sometimes global in extent. Porter terms this larger interconnected system of value chains the "value system." A value system includes the value chains of a firm's supplier (and their suppliers all the way back), the firm itself, the firm distribution channels, and the firm's buyers (and presumably extended to the buyers of their products, and so on).
Capturing the value generated along the chain is the new approach taken by many management strategists. For example, a manufacturer might require its parts suppliers to be located nearby its assembly plant to minimize the cost of transportation. By exploiting the upstream and downstream information flowing along the value chain, the firms may try to bypass the intermediaries creating new business models, or in other ways create improvements in its value system.
The Supply-Chain Council, a global trade consortium in operation with over 700 member companies, governmental, academic, and consulting groups participating in the last 10 years, manages the Supply-Chain Operations Reference (SCOR), the de facto universal reference model for Supply Chain including Planning, Procurement, Manufacturing, Order Management, Logistics, Returns, and Retail; Product and Service Design including Design Planning, Research, Prototyping, Integration, Launch and Revision, and Sales including CRM, Service Support, Sales, and Contract Management which are congruent to the Porter framework. The SCOR framework has been adopted by hundreds of companies as well as national entities as a standard for business excellence, and the US DOD has adopted the newly-launched Design-Chain Operations Reference (DCOR) framework for product design as a standard to use for managing their development processes. In addition to process elements, these reference frameworks also maintain a vast database of standard process metrics aligned to the Porter model, as well as a large and constantly researched database of prescriptive universal best practices for process execution.

Value Reference Model

A Value Reference Model (VRM) developed by the global not for profit Value Chain Group offers an open source semantic dictionary for value chain management encompassing one unified reference framework representing the process domains of product development, customer relations and supply networks.

The integrated process framework guides the modeling, design, and measurement of business performance by uniquely encompassing the plan, govern and execute requirements for the design, product, and customer aspects of business.

The Value Chain Group claims VRM to be next generation Business Process Management that enables value reference modeling of all business processes and provides product excellence, operations excellence, and customer excellence.

Six business functions of the Value Chain:

• Research and Development
• Design of Products, Services, or Processes
• Production
• Marketing & Sales
• Distribution
• Customer Service

To analyze the specific activities through which firms can create a competitive advantage, it is useful to model the firm as a chain of value-creating activities. Michael Porter identified a set of interrelated generic activities common to a wide range of firms. The resulting model is known as the value chain and is depicted below:

Primary Value Chain Activities

Inbound Logistics

>

Operations

>

Outbound Logistics

>

Marketing & Sales

>

Service

The goal of these activities is to create value that exceeds the cost of providing the product or service, thus generating a profit margin.

• Inbound logistics include the receiving, warehousing, and inventory control of input materials.

• Operations are the value-creating activities that transform the inputs into the final product.

• Outbound logistics are the activities required to get the finished product to the customer, including warehousing, order fulfillment, etc.

• Marketing & Sales are those activities associated with getting buyers to purchase the product, including channel selection, advertising, pricing, etc.

• Service activities are those that maintain and enhance the product's value including customer support, repair services, etc.

Any or all of these primary activities may be vital in developing a competitive advantage. For example, logistics activities are critical for a provider of distribution services, and service activities may be the key focus for a firm offering on-site maintenance contracts for office equipment.

These five categories are generic and portrayed here in a general manner. Each generic activity includes specific activities that vary by industry.

Support Activities

The primary value chain activities described above are facilitated by support activities. Porter identified four generic categories of support activities, the details of which are industry-specific.

• Procurement - the function of purchasing the raw materials and other inputs used in the value-creating activities.

• Technology Development - includes research and development, process automation, and other technology development used to support the value-chain activities.

• Human Resource Management - the activities associated with recruiting, development, and compensation of employees.

• Firm Infrastructure - includes activities such as finance, legal, quality management, etc.

Support activities often are viewed as "overhead", but some firms successfully have used them to develop a competitive advantage, for example, to develop a cost advantage through innovative management of information systems.

Value Chain Analysis

In order to better understand the activities leading to a competitive advantage, one can begin with the generic value chain and then identify the relevant firm-specific activities. Process flows can be mapped, and these flows used to isolate the individual value-creating activities.

Once the discrete activities are defined, linkages between activities should be identified. A linkage exists if the performance or cost of one activity affects that of another. Competitive advantage may be obtained by optimizing and coordinating linked activities.

The value chain also is useful in outsourcing decisions. Understanding the linkages between activities can lead to more optimal make-or-buy decisions that can result in either a cost advantage or a differentiation advantage.

The Value System

The firm's value chain links to the value chains of upstream suppliers and downstream buyers. The result is a larger stream of activities known as the value system. The development of a competitive advantage depends not only on the firm-specific value chain, but also on the value system of which the firm is a part.

Recommended Reading

Porter, Michael E., Competitive Advantage:Creating and Sustaining Superior Performance

In Competitive Advantage, Michael Porter introduces the value chain as a tool for developing a competitive advantage. Topics include:

• Sharing of value chain activities among business units.


• Using value chain analysis to develop low-cost and differentiation strategies.


• Interrelationships between value chains of different industry segments.


• Applying the value chain to understand the role of technology in competitive advantage.

The book concludes by considering the implications for offensive and defensive competitive strategy, including how to identify vulnerabilities and initiate an attack on the industry leader.

References
1. ^ Martin, James (1995). The Great Transition: Using the Seven Disciplines of Enterprise Engineering. New York: AMACOM. ISBN 978-0814403150., particularly the Con Edison example.
2. ^ "The Horizontal Corporation". Business Week. 1993-12-20.