Michael E.

Porter’s Value Chain Analysis

By- Paridhi Agarwal
Understanding How Value Is Created Within Organizations

How does your organization create value?

How do you change business inputs into business outputs in such a way that they have
a greater value than the original cost of creating those outputs?

This isn't just a simple question: it's a matter of fundamental importance to companies,
because it addresses the economic logic of why the organization exists in the first
place.
Manufacturing companies create value by acquiring raw materials and using them to
produce something useful.

Retailers bring together a range of products and present them in a way that's
convenient to customers, sometimes supported by services such as fitting rooms or
personal shopper advice.

And insurance companies offer policies to customers that are underwritten by larger
re-insurance policies. Here, they're packaging these larger policies in a
customer-friendly way, and distributing them to a mass audience.
The value that's created and captured by a company is the profit margin:

Value Created and Captured – Cost of Creating that Value = Margin

The more value an organization creates, the more profitable it is likely to be. And
when you provide more value to your customers, you build competitive advantage.

Understanding how your company creates value, and looking for ways to add
more value, are critical elements in developing a competitive strategy.
Introduction

A value chain is a set of activities that an organization carries out to create value for its
customers. Porter proposed a general-purpose value chain that companies can use to
examine all of their activities, and see how they're connected. The way in which value
chain activities are performed determines costs and affects profits, so this tool can help
you understand the sources of value for your organization.

Michael Porter introduced the Generic Value Chain Model in 1985.

Value Chain Analysis is a strategy tool used to analyse a firm’s activities by recognizing
which activities are valuable to the firm and which needs to improved

It involves identification of Primary and supportive activities that add value to the final
product.
Elements in Porter's Value Chain
Rather than looking at departments or accounting cost types, Porter's Value Chain focuses on systems, and
how inputs are changed into the outputs purchased by consumers. Using this viewpoint, Porter described a
chain of activities common to all businesses, and he divided them into primary and support activities, as
shown below.
 What are Primary Activities in Porter’s VCA ?

Primary activities relate directly to the physical creation, sale, maintenance and support of a
product or service. They consist of the following:

● Inbound logistics – These are all the processes related to receiving, storing, and
distributing inputs internally. Your supplier relationships are a key factor in creating
value here.
● Operations – These are the transformation activities that change inputs into outputs
that are sold to customers. Here, your operational systems create value.
● Outbound logistics – These activities deliver your product or service to your
customer. These are things like collection, storage, and distribution systems, and
they may be internal or external to your organization.
Primary Activities

● Marketing and sales – These are the processes you use to persuade clients
to purchase from you instead of your competitors. The benefits you offer, and
how well you communicate them, are sources of value here.
● Service – These are the activities related to maintaining the value of your
product or service to your customers, once it's been purchased
 What are Secondary Activities in Porter’s VCA ?

These activities support the primary functions above. In our diagram, the dotted lines show that each
support, or secondary, activity can play a role in each primary activity. For example, procurement
supports operations with certain activities, but it also supports marketing and sales with other activities.

● Procurement (purchasing) – This is what the organization does to get the resources it needs
to operate. This includes finding vendors and negotiating best prices.
● Human resource management – This is how well a company recruits, hires, trains, motivates,
rewards, and retains its workers. People are a significant source of value, so businesses can
create a clear advantage with good HR practices.
Secondary / Support Activities

● Technological development – These activities relate to managing and

processing information, as well as protecting a company's knowledge base.
Minimizing information technology costs, staying current with technological
advances, and maintaining technical excellence are sources of value creation.
● Infrastructure – These are a company's support systems, and the functions
that allow it to maintain daily operations. Accounting, legal, administrative, and
general management are examples of necessary infrastructure that
businesses can use to their advantage
How to Improve the Value Chain ?

When a firm takes into account its value chain, it needs to consider its value proposition,
or what sets it apart from its competitors.

Value chain analysis is designed to improve profits by creating a product or service that
is so superior that customers are willing to pay more than the cost to develop it.

But improving a value chain for the sake of improvement should not be the end goal.
Instead, a company should decide why it wants to improve its value chain in the context
of its competitive advantage to differentiate itself among its peers.
Two common competitive advantage strategies include low cost provider or
specialization/differentiation of product or service.

● Low-cost provider – value chain analysis focuses on costs and how a

company can reduce those costs.
● Differentiation – value chain analysis focuses on the activities that create a
unique product or differentiation in service.
Bottom line is..

Value chain analysis is a handy management tool which identifies the activities that go into creating a
superior product or service that is highly valued by customers. The outcome of creating this highly
valued product is that customers are willing to pay a premium, which exceeds its costs, thereby
delivering higher profit.

The usefulness of this model created by Michael Porter is mostly seen in its ability to breakdown work
product into various activity groups to strategically focus the management on what are beneficial
activities, and what creates value. It also concentrates a company to determine a vision utilizing a
competitive advantage strategy which will drive future products and services. Supporting activities are
further validated in the process, creating an understanding that these sometimes overlooked activities
are integral to the value chain and value proposition for a company.