Value Chain

The value chain is a popular business management concept that was originated by Porter (1985). Porter argues that every firm has a collection of strategically important activities that are performed to design, produce, market, deliver, and support its product, and that those activities can be grouped into a series of sequential, value-adding stages, forming a chain. Products pass through every activity of the chain, gaining some value at each successive activity.

The goal of the activities of a firm is to offer the customer a level of value that exceeds or offsets the combined costs of the activities, thus resulting in a profit margin. In essence, the value chain is a tool for identifying and analyzing the sources of firm-level competitive advantage.

Porter asserts that a firm’s value chain and the way it performs its individual activities are a reflection of its history, its strategy, its approach to implement-ing its strategy, and the underlyimplement-ing economics of the activities themselves, and that although firms in the same industry may have similar value chains, the value chains of competitors often differ. Porter uses a generic value chain model as illustrated in Figure 2.1 to describe the common value activities of firms. These value activities can be grouped into five generic categories of primary activities which directly contribute to creating and bringing value to the customer, and four generic categories of support activities which enable and improve the performance of the primary activities. (Porter, 1985)

The primary activity categories are:

• Inbound Logistics: the receiving, warehousing, and disseminating of in-puts, and their transportation to manufacturing as required.

Firm Infrastructure Human Resource Management

Technology Development Procurement Inbound

Logistics

Operat-ions

Outbound Logistics

Marketing

& Sales

Service Mar

gin

Margin

Figure 2.1: Porter’s generic value chain model

• Operations: transforming inputs into final products: e.g., machining, packaging, assembly, testing, and facility operations.

• Outbound Logistics: collecting, warehousing, and distributing the fin-ished goods to buyers.

• Marketing & Sales: providing means (sales channels, sales force) by which buyers can purchase the product and inducing them to do so through advertising, promoting, etc.

• Service: after-sales support of customers who have purchased the prod-uct, covering installation, maintenance, repair, training, part supply, etc.

The support activity categories are:

• Firm Infrastructure: general management, planning, finance, account-ing, legal, government affairs, quality management, standardization, in-formation systems, etc.

• Human Resource Management : recruiting, hiring, training, develop-ment, and compensation of all types of personnel for both primary and support activities.

• Technology Development : broad range of activities aiming at product or process improvements, or more generically, to improve any technology embodied in the value activities.

• Procurement : purchasing inputs such as raw materials, supplies, and other consumable items, as well as assets including machinery, equip-ment, buildings, etc.

A firm’s ability to generate margin or profit is dependent on its effectiveness in performing the activities efficiently, so that the price that the customer is willing to pay for the products more than offsets the costs of the activities.

Each activity in the value chain, in principle, provides an opportunity to gen-erate superior value as compared to competitors. Therefore, a competitive advantage may be attained by reconfiguring the value chain to provide either lower cost or better differentiation.

The value chain concept has been extended beyond the boundaries of indi-vidual firms. A firm’s value chain can be considered part of a larger system that includes the value chains of upstream suppliers, downstream channels, and buyers. Porter has named this series of value chains as the value system, illustrated conceptually in Figure 2.2 (Porter, 1985).

... ^FirmValue Chain

Channel Value Chain Supplier

Value Chain

Buyer Value Chain

Figure 2.2: Porter’s value system

While the activities within a value chain are related through linkages, these linkages exist not only in a firm’s value chain, but also between value chains of different firms. Managing linkages often involves trade-offs between opti-mization and coordination. Although a firm with a high degree of vertical integration (i.e., a wide scope of internal activities spanning partially or fully the domains of suppliers, channels, and/or buyers) is better equipped to coor-dinate upstream and downstream activities, a firm with a lesser degree of ver-tical integration can nevertheless make agreements with suppliers and channel partners to achieve better coordination, e.g., through geographical co-location or proximity. Thus, the exploitation of vertical linkages does not necessarily require vertical integration, but integration may make it easier to reap the benefits of those linkages. It is clearly evident that a firm’s success in develop-ing and sustaindevelop-ing a competitive advantage depends not only on its own value chain, but also its ability to manage the value system it belongs to. (Porter, 1985)

Criticism

Although still widely used as an analysis tool, the value chain framework has been criticized for focusing too much on the unidirectional flow of materials and transformation of inputs into products as a means to create value. Un-doubtedly, the primary activity taxonomy of the value chain is well suited

to describing and analyzing a traditional manufacturing firm, but less so for many firms operating in the services and knowledge industries, as argued by Stabell & Fjeldstad (1998). Moreover, for industries such as insurance and banking, trying to assign and analyze activities in terms of the five primary activity categories is not only difficult, but can also obscure the value creation logic rather than illuminate it. Although it is possible to describe, e.g., the document flow of an insurance company using the value chain model, such a model hardly captures the essence of the value creation, as the logic of many strategically important activities (reinsurance, risk assessment, customer rela-tionship management, etc.) cannot be effectively described using the logistics and transformation focused approach of the value chain. A similar case can be made for banking, where the value chain is unable to deal explicitly with both lenders and borrowers as bank customers. The model also serves to ob-scure the value creation logic by putting too much emphasis on transaction processing and its associated unit costs, while all but ignoring interest spread and risk management (Stabell & Fjeldstad, 1998).

Through the identification of alternative means of value creation, Stabell &

Fjeldstad (1998) have generalized value chain analysis into what they call value configuration analysis. Porter’s value chain is seen as one of three alternative value configuration models, the others being the value shop and the value network. These models are discussed in the following sections.