Businesses wishing to do more to delight customers and gain an edge over their competitorscan turn to the time-tested “value chain” approach for evaluating and improvingtheir entire operations from the point of view of how they produce value for the customer.For example, by comparing the cost of each step of the production process to the value thatgets added to a product at that step, businesses can shine a light on which steps are addingthe most value that entices customers and offer the most bang for the buck.
Analyzing their operations using value chain thinking helps businesses pinpoint the exactactivities that create their competitive edge or weakness so they can find the most crucialareas for improvement. By strengthening the individual links in the chain, the entireoperation becomes stronger and more efficient — giving businesses more ways to beatout their competition.
What Is a Value Chain?
A value chain is a model that includes every step a company goes through — from theinitial idea through delivery to the customer — to create a good or service. The valuechain includes initial design, materials sourcing, manufacturing, marketing, sale, deliveryand after-sale service. If that sounds a lot like a supply chain, it should. Value chainsencompass more business activities than supply chains, but the main difference is theircustomer-focused point of view.
By studying the value chain, businesses can go step by step to find places to add values thatcustomers look for when choosing where to spend their money. Not every business has the timeor resources to perform a full analysis of its value chain — that would require a deeplook at every step of production for every product — but many companies benefit fromsome value chain analysis on their highest-cost products, specific departments or anywherethey feel that a deeper look is needed before implementing efficiency improvements.
Key Takeaways
- The value chain is the series of steps businesses go through to create a finishedproduct — from the initial idea to customer delivery.
- Value chains have two categories of components: the direct, or primary, activitiesneeded to make and sell a good and support activities that affect efficiency of theprimary activities.
- Businesses analyze the value chain to find ways they can increase customer value, eitherby reducing costs or differentiating their goods with features customers prize. Bothapproaches yield potential competitive advantage.
Value Chains Explained
The goal of the value chain model is to help a business gain an advantage over itscompetitors by increasing the value its products offer to customers. Once decision-makers ormanagers map out the steps in the value chain — either for one product or as a broadlook at a company’s processes — they can analyze the costs and rewards of eachstep. That analysis then informs decisions about decreasing costs or increasing the value ofa product in the eye of the customer. Lower costs can lead to higher profit margins or lowerprices for the good, creating a “cost advantage” over competitors. And whencustomers view a product as more valuable than a comparable good, they are often willing topurchase it more often or pay higher prices, giving the business a “differentiationadvantage”.
For example, let’s say a company’s value chain analysis highlights that its useof high-quality raw materials is driving up the cost of manufacturing. If thecompany’s goal is to gain a cost advantage over competitors, it can considercost-cutting measures like changing suppliers or outsourcing costly parts of the process. Ifthe business is aiming for a differentiation advantage, it can emphasize its high-qualitymaterials and manufacturing processes in its marketing, positioning the product as a premiumitem — and charging a premium price. Both approaches to competitive advantage arepossible when a business understands its value chain, and both have the same ultimatefinancial goal — higher profits.
Value Chain Origins
The term “value chain” was first coined in 1985 by Michael E. Porter of theHarvard Business School in his book Competitive Advantage: Creating and SustainingSuperior Performance. Its second chapter opens with the following lines,introducing what Porter called the “value chain”: “Competitive advantagecannot be understood by looking at a firm as a whole. It stems from the many discreteactivities a firm performs in designing, producing, marketing, delivering and supporting itsproduct.”
Porter goes on to emphasize customer value over cost as the crucial point of view from whichto seek competitive advantage: “Value is the amount buyers are willing to pay for whata firm provides them … Value, instead of cost, must be used in analyzing competitiveposition since firms often deliberately raise their cost in order to command a premium pricevia differentiation”.
Porter’s work showed businesses that focusing simply on reducing costs is only afraction of the battle to win customers and stay competitive. By framing thecustomer’s opinions and preferences as a business’s primary focus, the valuechain helps businesses differentiate from competitors and gain advantages in the market— even if they raise costs in the process. Customers are often willing to pay higherprices for products they perceive as higher value, whether that value comes from perceivedhigher quality, specific features or through marketing, customer service and salestechniques.
Porter’s value chain model is still used today by businesses to create and maintaincompetitive advantage.
How Do Value Chains Work?
The value chain breaks up a business’s processes and expenses into individual steps andweighs each one against the value it adds to the product. To determine how effectively valueis added, many companies analyze sales data or employ surveys and market research to heardirectly from customers about how they value products and what they think should be improvedor added to a particular good or service. By analyzing the value created at each step,businesses can more accurately price their products and keep their demand high — bothfor their premium products and their lower-value alternatives.
For example, if a business makes and sells musical instruments, its value chain would includethe procurement of raw materials — like the wood used for the body of a guitar and themetal in the electronics — the entire manufacturing process, marketing, sales andsupport. For the guitar manufacturer Fender, higher-quality wood and more skilled craftsmenare employed to create the American-made Stratocaster compared with Stratocasters made inMexico. By spending more on labor and materials in the United States, Fender increases thevalue of an American-made guitar and charges almost double the price of a Mexican-madeguitar. While they share many components, the steps in the value chain that vary between thetwo guitars change each product’s value, costs and the price customers are willing topay. By analyzing sales data and surveying musicians, Fender can correlate the prices forboth guitars with the value difference that customers “feel” between the twogoods, maintaining demand for both options.
The Importance of a Value Chain
Value chain modeling is important for businesses trying to gain advantages over theircompetition, or maintain advantages they already have, because it helps them preciselyidentify where in their processes customer value is created. In his book, Porter describedthe importance of the value chain like this: “A systematic way of examining all theactivities a firm performs and how they interact is necessary for analyzing the sources ofcompetitive advantage… A firm gains competitive advantage by performing thesestrategicallyimportant activities more cheaply or better than its competitors”.
Industries are constantly evolving through new technologies, processes, suppliers, marketingstrategies and, most important, changing customer demands. Businesses seeking to stay aheadof the curve need to evolve alongside customers’ ever-changing wants and needs byregularly analyzing and improving the value that their products offer. They can do thisthrough studying and optimizing steps in the value chain. If a business is the lone supplieror far ahead of the competition, finding advantages based on value differentiation may notbe a top priority. In that case, the value chain can be analyzed through the lens of supply chain bestpractices to find lower costs or higher productivity, which increase margins.
Components of a Value Chain
When Porter first wrote about the value chain, he split the components of the chain into twocategories — primary and secondary activities — that are still used today bymanagers and analysts. Both are critical aspects of the value chain and contribute to theoverall value of the company’s goods or services.
Primary Activities
Primary activities are made up of five steps that are directly involved in producing orselling a product and meeting external demands, the first three of which are roughlyequivalent to supply chainmanagement. These five steps are:
- Inbound logistics: This activity focuses on the relationship withsuppliers and raw materials — sourcing, procurement, receiving, warehousing,inventory and storage. Inefficient inbound logistics raise the direct costs of producinggoods and reduce profit margins.
- Operations: Manufacturingoperations include all of the processes that take raw materials and turn theminto the final product — including labor costs and machinery. An optimizedoperation can decrease order turnover time and reduce costs.
- Outbound logistics: Once a final product is manufactured, outboundlogistics takes over through processes like distribution, inventory managementand order processing. In the ecommerce world of two-, one- or same-day shipping, manycustomers value a quick and transparent outbound logistics system.
- Marketing and sales: Marketing and sales informs the customer about thegood or service — and the value it provides — and provides a way for acustomer to purchase it. It includes presale processes like quotes and pricing.
- Service: Many businesses provide services to improve or maintain aproduct’s value after the sale, like installation, repair, warranties, refunds,training or replacement/supplemental supplies. For expensive or long-term goods likeappliances, many customers value reliable service above other features. Some companiesimplement reverse logistics tosupport customer returns.
Support Activities
Support activities affect how efficiently the primary activities operate. They are dividedinto four categories:
- Infrastructure: Infrastructure focuses on company structure andmanagement. Planning, finances and legal systems contribute to a firm’sinfrastructure and inform business decisions. Value-chain analysis and optimization isusually performed by the managers, accountants and analysts who work in theseinfrastructure departments.
- Technological development: Many companies focus on research anddevelopment (R&D), but some view this activity more broadly than just R&D andexpand it to mean any technology improvements. As described in Porter’s book,technological development “occurs in many parts of a firm … including suchareas as telecommunications technology for the order entry system, or office automationfor the accounting department”. Technology can be used to reduce costs and moreefficiently utilize the workforce.
- Human resources management: Human resources (HR)management includes all of the activities related to hiring, training and retainingstaff. A well-trained staff with a high retention rate can help quickly identifyinefficiencies in operations and add direct value to customers through good service.
- Procurement: In the value chain, procurement, according to Porter, “refersto the function of purchasing inputs used in the firm’s value chain, not to thepurchased inputs themselves.” These inputs are more than just raw materials— though raw materials rightfully get a lot of attention. They include machinery,laboratory and office equipment and buildings. Procurement provides the resources neededfor most of the other activities — both primary and support — to operate andadd their value to the product and the company.
Virtual Value Chain
The internet has shifted many customers and businesses from only physical goods and servicesto a mix of physical and virtual. That shift has created new types of “virtualvalue,” such as data and user experiences, leading to the virtual value chain concept.The virtual value chain focuses on these steps:
- Information gathering: Businesses first must collect as muchinformation as they can on their customers, industry, the current state of the marketand regulations to ensure that they are providing their goods or services effectivelyand satisfying customers’ needs.
- Organization of information: Data collected by companies must beorganized so it can be studied and analyzed. Without proper organization, the sheervolume of information captured can render it useless to the business, overwhelming eventhe savviest managers.
- Selecting what will be shared with customers: During this phase,businesses decide which information they will use to provide their product or service.For example, if a streaming service has collected enough data on the formats itscustomers prefer, this step will establish how the business’s content will bedelivered to customers.
- Synthesizing information: The virtual product is finalized and preparedfor delivery to the customer. Formatting, virtual “packaging” and userinterface are major aspects of synthesis.
- Information distribution: Finally, the product is delivered to thecustomer/user. To use the streaming service example, this is when the customer canfinally watch a film. In an analogous physical value chain, this is where the deliveryof a DVD would occur. Both physical and virtual value chains have the same goal —satisfied customers buying and using the product.
Value Chain vs. Supply Chain
“Versus” isn’t the best way to express the relationship between valuechains and supply chains, since they largely overlap. The entirety of the supply chain is contained inside the value chain, sodrawing a line between them can be tricky. The primary difference between the two is theirfocus. The supply chain is focused on the business’s needs, centered around how acompany gets everything necessary to create its products or services. The value chain isfocused on customers and what they look for when prioritizing where they spend their money.Both are important for businesses to consider: The value chain and the supply chain shouldwork hand in hand to allow a business to balance its needs and priorities with itscustomers’, creating value for both at every link of the two chains.
Value Chain Examples
2pure, a wholesale distributor based in the U.K., defines its core purpose as adding“value in ways which improve the experience of all participants in everyinteraction.” But to effectively add value, 2pure needed to evaluate its value chainto find areas for improvement. Starting at the warehouse level, optimizing its distributionprocess cut its needed warehouse space by 40%. Further along the value chain, integratingpreviously disconnected processes and new technological developments — like a newwebsite — reduced its sales staff’s time by 25%, increasing productivity. Thesevalue chain improvements led to a 95% increase in revenue without adding any additionalstaff.
Kentucky-based Accuserv grew out of an electrical company that found its customers —multifacility businesses, including national restaurants and hotels — had needs thatwere not being met by their current distributors. Seeing an opportunity to add new value toits services, Accuserv expanded to offer services like flooring, fixtures and HVAC, creatinga managerial-adjacent role for the construction projects that many customers needed. Bystudying the values that customers were looking for — especially values that were notbeing met by competitors — Accuserv was able to show six straight years ofdouble-digit growth, forging its own niche to deliver customers exactly what they needed.
Streamline Your Value Chain With NetSuite
Creating a value chain for every product or service may seem like a daunting task for acompany with multiple products and/or services. But NetSuite Supply Chain Management makes iteasier, giving businesses visibility on which areas can be improved by way of thorough dataacross their supply chains. NetSuite’s solutions help business managers monitor andanalyze every step of production, from incoming materials from suppliers to trackingcustomers’ orders, ensuring that each step is adding value — for both thebusiness and for the customer.
In addition, NetSuite’s software gives businesses accurate and real-time inventory,order and financial data to effectively plan demand and forecast sales, minimizing over- andunderstocks. By integrating data from throughout an organization, NetSuite gives businessesa big-picture view of the value chain, ensuring that each step is running smoothly and thateach link in the chain is not only strong, but well-connected and working in harmony withthe rest of the organization.
The value chain has been an important model for improving businesses for decades. By framingthe customer’s desires as the primary method for producing a good or service, themodel leads businesses to increase the value of their products in two main ways — byreducing costs and by increasing their products’ appeal. Both goals can increaseprofit and give businesses an advantage over competitors while satisfying customers’needs, making value chain improvements a win-win for both businesses and customers.
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Value Chain FAQs
What is a value chain analysis?
Value chain analysis is a method for evaluating each step in a business’s process thatadds value to a good or service. Each step can be optimized based on the needs and goals ofthe company and its customers.
What are the goals and outcomes of value chain analysis?
Companies can use value chain analysis to gain advantages over their competitors. This can bedone by either reducing costs to lower prices and/or increase profits or by differentiatinggoods to increase their value.
What are the benefits of a value chain analysis?
A value chain analysis can give managers visibility on where a business’s costs arehighest and where the most value is added to its goods or services. Value chain analysis canalso give decision-makers insight into where efficiency improvements can be made.
What are value chain management and mapping?
Value chain mapping organizes all the steps of a value chain to give managers more visibilityinto the processes and how they are interconnected. Value chain management is the process ofbusiness decision-makers using value chain mapping to effectively implement strategies andoversee the steps of the value chain.
What is an example of a successful value chain?
2pure, a U.K.-based distributor, made improvements throughout its value chain —including warehouse operations and sales — to increase its revenue by 95% withouthiring any additional staff.
Why does value chain analysis matter?
Value chain analysis helps businesses successfully compete by showing areas where they cangain an advantage over competitors. Michael E. Porter, who coined the term “valuechain,” defined it as a “systematic way of examining all the activities a firmperforms and how they interact is necessary for analyzing the sources of competitiveadvantage”.
What is a value chain with examples?
A value chain is every step involved with a business’s production, from the idea of agood or service to customer delivery and after-sale support. For example, guitarmanufacturer Fender uses higher-quality raw materials and more skilled craftsmen during themanufacturing process to create the American-made Stratocaster guitar compared withStratocasters made in Mexico. By spending more on labor and materials in the U.S., Fenderalso increases the value of an American-made guitar, for which it charges almost double theprice of a Mexican-made guitar.
What are the types of value chains?
There are two main types of value chains. Physical value chains are used in the productionand delivery of physical goods. Virtual value chains are used to deliver information ordigital goods to customers/users.
What are the four components of the value chain?
There are four components of the “support activities” aspect of a value chain— infrastructure, human resource management, technology development and procurement.The five “primary activities” of the value chain are inbound logistics,operations, outbound logistics, marketing and sales and service.
