What Is the Value Chain?

Porter introduced the model in the book "Competitive Advantage: Creating and Sustaining Superior Performance", published by Free Press in New York in 1985. According to his institute at Harvard Business School, the value chain disaggregates a company into its strategically relevant activities in order to find the sources of competitive advantage: the activities that result in higher prices or lower costs.

One misreading is to equate the value chain with the supply chain. The difference lies in what each one looks at. The value chain looks inside one company and includes activities that move no goods, such as managing people or developing technology. The supply chain follows the product from company to company, from raw material to customer. Porter has a name for the chain across companies too: according to the Harvard institute, a company's value chain is part of a larger value system, with suppliers upstream and distribution channels downstream.

Anyone who equates the two reviews purchasing, warehousing and transport and believes they have analysed their value chain. Missing are three of the four support activities, along with marketing and sales, service and the question of margin.

The primary activities concern creating, selling, delivering and supporting the offer. The German business dictionary Gabler summarises them like this: - Inbound logistics: receiving, storing and providing the inputs for production. - Operations: turning those inputs into products or services. - Outbound logistics: storing, distributing and delivering what has been produced. - Marketing and sales: working the market, winning customers and selling. - Service: what maintains the value of the offer during and after the sale.

The four support activities sustain the primary ones: - Firm infrastructure: management, planning, finance, controlling and other company-wide functions. - Human resource management: recruiting, developing and managing people. - Technology development: technologies, procedures and knowledge. - Procurement: buying what all the activities need.

The margin completes the model. According to Gabler, the value of an offer is what buyers are willing to pay for it, and the margin is the difference between that value and the cost of all the activities.

The first step is to choose the unit: the whole company, a business unit or another unit that makes sense to analyse. In a company with several lines, each line can have its own chain.

The second step is to assign each activity its costs and its contribution to value for the customer. The activities in the model are categories for analysis, not departments. Gabler stresses this: they do not have to match the organisation chart.

The third step is to look at the linkages. According to Gabler, a change in one activity can change the cost, quality or performance of others. An expensive customer service operation can make returns cheaper; a cheap supplier can make production more expensive. Gabler gives these linkages their own weight, alongside that of each activity.

The fourth step is to compare with competitors: in which activities is the company cheaper, or where does it do something differently? That, according to Porter's institute, is where competitive advantage lies. The institute puts it this way: integrating best practices is essential, but doing things effectively is not the same as doing things differently.

Gabler notes that in service, knowledge or network businesses, the classic activities have to be adapted to the way that business creates value.

The value chain brings strategy down to the level of activities. "We are more efficient" cannot be checked. "Our outbound logistics cost less per order than our competitor's" can. That is why the model helps decide what to do in-house, what to outsource and where to invest.

Other tools share the work. Benchmarking compares specific processes with other companies, and the value chain says which processes are worth comparing. The decisions in the marketing mix make up one of the five primary activities, marketing and sales, and depend on the others: a low price calls for cheap logistics. The BCG matrix sorts the units of a portfolio; the value chain looks inside each one.

Porter's five forces explain how much profit an industry leaves. The value chain explains the other half, the company's position within that industry. On the Business Model Canvas, the key activities and key resources are where the value chain goes into detail.

• Choose the unit of analysis before starting and write it next to the chain.
• Assign costs to the activities in the model, not to the departments on the organisation chart.
• Include the four support activities, even though they move no product.
• Look for the linkages between activities, not only the cost of each one.
• Compare each relevant activity with that of competitors.
• Adapt the activities if the company sells services or knowledge.

• Confusing the value chain with the supply chain.
• Reviewing only purchasing, production and transport and forgetting the support activities.
• Copying the organisation chart instead of using the activities in the model.
• Listing activities without asking which ones the cost and the differentiation come from.
• Applying the classic activities unchanged to a service business.
• Mistaking other companies' best practices for an advantage of one's own.