Concept of Value chain approaches

Dr.Kedar Karki

Introduction:
The value chain approach was developed by Michael Porter in the
1980s in his book “Competitive Advantage: Creating and Sustaining
Superior Performance” (Porter, 1985). The concept of value added, in
the form of the value chain, can be utilized to develop an
organisation’s sustainable competitive advantage in the business arena
of the 21st C. All organisations consist of activities that link together
to develop the value of the business, and together these activities
form the organisation’s value chain. Such activities may include
purchasing activities, manufacturing the products, distribution and
marketing of the company’s products and activities (Lynch, 2003). The
value chain framework has been used as a powerful analysis tool for
the strategic planning of an organisation for nearly two decades. The
aim of the value chain framework is to maximise value creation while
minimising costs.

Main aspects of Value Chain Analysis

Value chain analysis is a powerful tool for managers to identify the key
activities within the firm which form the value chain for that
organisation, and have the potential of a sustainable competitive
advantage for a company. Therein, competitive advantage of an
organisation lies in its ability to perform crucial activities along the
value chain better than its competitors.
The value chain framework of Porter (1990) is “an interdependent
system or network of activities, connected by linkages” (p. 41). When
the system is managed carefully, the linkages can be a vital source of
competitive advantage (Pathania-Jain, 2001). The value chain analysis
essentially entails the linkage of two areas. Firstly, the value chain
links the value of the organisations’ activities with its main functional
parts. Then the assessment of the contribution of each part in the
overall added value of the business is made (Lynch, 2003). In order to
conduct the value chain analysis, the company is split into primary and
support activities (Figure 1). Primary activities are those that are
related with production, while support activities are those that provide
the background necessary for the effectiveness and efficiency of the
firm, such as human resource management. The primary and secondary
activities of the firm are discussed in detail below.

Primary activities

1
The primary activities (Porter, 1985) of the company include the
following:
• Inbound logistics

These are the activities concerned with receiving the materials from
suppliers, storing these externally sourced materials, and handling
them within the firm.

• Operations

These are the activities related to the production of products and

services. This area can be split into more departments in certain
companies. For example, the operations in case of a hotel would
include reception, room service etc.
• Outbound logistics

These are all the activities concerned with distributing the final
product and/or service to the customers. For example, in case of a
hotel this activity would entail the ways of bringing customers to the
hotel.
• Marketing and sales:

This functional area essentially analyses the needs and wants of

customers and is responsible for creating awareness among the target
audience of the company about the firm’s products and services.
Companies make use of marketing communications tools like
advertising, sales promotions etc. to attract customers to their
products.
• Service

There is often a need to provide services like pre-installation or after-

sales service before or after the sale of the product or service.

Support activities

The support activities of a company include the following:

• Procurement

This function is responsible for purchasing the materials that are

necessary for the company’s operations. An efficient procurement
department should be able to obtain the highest quality goods at the
lowest prices.

• Human Resource Management

2
This is a function concerned with recruiting, training, motivating and
rewarding the workforce of the company. Human resources are
increasingly becoming an important way of attaining sustainable
competitive advantage.

• Technology Development

This is an area that is concerned with technological innovation,

training and knowledge that is crucial for most companies today in
order to survive.

• Firm Infrastructure

This includes planning and control systems, such as finance,

accounting, and corporate strategy etc. (Lynch, 2003).
Figure 1

The Value Chain

Source: Porter (1985)

Porter used the word ‘margin’ for the difference between the total
value and the cost of performing the value activities (Figure 1). Here,
value is referred to as the price that the customer is willing to pay for
a certain offering (Macmillan et al, 2000). Other scholars have used
the word ‘added value’ instead of margin in order to describe the same
(Lynch, 2003). The analysis entails a thorough examination of how each
part might contribute towards added value in the company and how

3
this may differ from the competition.
In a study of Saudi companies, Ghamdi (2005) found that 22% of the
companies in the study used value chain frequently, while 17%
reported that they somewhat used it, and 42% did not use the tool at
all. An interesting finding of the study was that the manufacturing
firms were frequent users of the tool compared to their service
counterparts (Ghamdi, 2005).

How to write a Good Value Chain Analysis

The ability of a company to understand its own capabilities and the

needs of the customers is crucial for a competitive strategy to be
successful. The profitability of a firm depends to a large extent on how
effectively it manages the various activities in the value chain, such
that the price that the customer is willing to pay for the company’s
products and services exceeds the relative costs of the value chain
activities. It is important to bear in mind that while the value chain
analysis may appear as simple in theory, it is quite time-consuming in
practice. The logic and validity of the proven technique of value chain
analysis has been rigorously tested, therefore, it does not require the
user to have the same in-depth knowledge as the originator of the
model (Macmillan et al, 2000). The first step in conducting the value
chain analysis is to break down the key activities of the company
according to the activities entailed in the framework. The next step is
to assess the potential for adding value through the means of cost
advantage or differentiation. Finally, it is imperative for the analyst to
determine strategies that focus on those activities that would enable
the company to attain sustainable competitive advantage.
It is important for analysts to remember to use the value chain as a
simple checklist to analyse each activity in the business with some
depth (Pearson, 1999). The value chain should be analysed with the
core competence of the company at its very heart (Macmillan et al,
2003). The value chain framework is a handy tool for analysing the
activities in which the firm can pursue its distinctive core
competencies, in the form of a low cost strategy or a differentiation
strategy. It is to be noted that the value chain analysis, when used
appropriately, makes the implementation of competitive strategies
more systematic overall. Analysts should use the value chain analysis
to identify how each business activity contributes to a particular
competitive strategy. A company may benefit from cost advantages if it
either reduces the cost of individual activities in the value chain or the
value chain is essentially reconfigured, through structural changes in

4
the activities. One of the problematic areas of the value chain model,
however, is that the costs of the different activities of the value chain
need to be attributed to an activity. There are few costing systems
that contain detailed activity level costing, unless an Activity Based
Costing (ABC) system is in place in the company (Macmillan et al,
2003). Another relevant area of concern that analysts must pay
particular attention to is the customers’ view point of value. The
customers of the firm may view value in a generic way, thereby making
the process of evaluating the activities in the value chain in relation
with the total price increasingly difficult. It is imperative for analysts
to note that the overall differentiation advantage may result from any
activity in the value chain. A differentiation advantage may be
achieved either by changing individual value chain activities to
increase uniqueness in the final product or service of the company, or
by reconfiguring the company’s value chain.

The difference between a low cost strategy and differentiation in

practice is unlike the rigidity that is provided regarding the same in
theory. Analysts must note that the difference between these two
strategies is one of the shades of grey in real life compared to the
black and white that is offered in theory. For example, Emerson
Electric, which is a cost leader, has quality as a strategic concern in
achieving its ‘best costs’ strategy (Pearson, 1999). Ivory Soap, a
leading product of P&G, is a broad differentiator that turned into a
cost leader. Quality is a strategic concern for managers of Ivory Soap,
along with delivering a high value product consistently.
Note that in a company with more than one product area, it is
appropriate to conduct the value chain analysis at the product group
level, and not at the corporate strategy level. It is crucial for
companies to have the ability to control and make most of their
capabilities. In the advent of outsourcing, progressive companies are
increasingly making their value chains more elastic and their
organisations inherently more flexible (Gottfredson et al, 2005). The
important question is to see how the companies are sourcing every
activity in the value chain. A systematic analysis of the value chain can
facilitate effective outsourcing decisions. Therefore, it is important to
have an in-depth understanding of the company’s strengths and
weaknesses in each activity in terms of cost and differentiation
factors.
The strategy of Wal-Mart worked when the company improved its
business through innovative practices in activities such as purchasing,
logistics, and information management, which resulted in the value
offering of “everyday low prices” (Magretta, 2002). It is important to
note that refining business models on a constant basis is as critical to

5
the success of the company as its business strategy. Notably, both the
strategy and business model of an organisation are crucial for the
robustness of the overall value chain.

For example, 7-Eleven had been vertically integrated, controlling most

activities in the value chain by itself. The company has now outsourced
many parts of its business including functions like HR, IT management,
finance, logistics, distribution, product development, and packaging.
According to Gottfredson et al (2005), the value chain decisions of
companies will increasingly shape their overall organisational
structure. Moreover, the value chain decisions will play a role in
determining the type of management skills that companies may need
to develop or acquire to survive in fiercely competitive business
markets.
The Apple podcasting value chain is comprised of nine steps that
essentially move from raw content to the listener. All the steps of the
value chain include content, advertising, production, publishing,
hosting/bandwidth, promotion, searching, catching, and listening. It is
important to note that each step in the value chain adds value to the
podcast in distinctive ways, has its own sets of challenges and
opportunities.
It is important to note that the nature of value chain activities differs
greatly in accordance with the types of companies and industries. For
companies with complex systems like IBM, Accenture and Cisco etc., it
is not possible for one member of the value chain to provide all the
products and services from start to finish. The marketing function in
such companies focuses on aligning with key partners and allies that
must collaborate with each other. For example, installing SAP's ERP
system requires direct involvement from companies like HP, Oracle,
and Accenture, along with indirect involvement of companies like EMC,
Cisco, and Microsoft, and collaboration between many departments
within the company. The market assets contrast starkly between the
companies with complex systems and those that are driven by volume
operations. For example, in case of Apple’s leading products like
Macintosh and the iPod, the entire offer is inside a package, and the
entire value chain is preassembled. The change of supplier for the
Macintosh from IBM, to Intel, improved the system performance while
retaining the value in terms of price to the consumer. The only
variable to manage in Apple’s case is the consumers’ preferences. The
role of creating differentiation through unique quality features, along
with promotion in order to create brand awareness, image and
eventually brand equity becomes imperative for volume operations
driven companies like Apple (Moore, 2005).
It is imperative to note that the value chains of companies have

6
undergone many changes over the last two decades, due to the rapidly
changing business environment. Information technology and the
Internet have played a fundamental role in transforming certain parts
and the interlinkages between parts of the value chains of companies
today. Moreover HRM is increasingly becoming a vital asset in the value
chain that contributes to competitive advantage. Strategic alliances
are also becoming an integral part of the value chains. For example,
IBM once enjoyed backward vertical integration into the disk drive
industry and forward vertical integration into the consulting services
and computer software industries (Hill et al, 2007). According to the
changing business environment, IBM had more than 400 strategic
alliances as of 2003 (Thompson et al, 2003). Herein, the value chain
analysis is useful in providing a framework to examine the advantages
that partners can give to each other (Pathania-Jain, 2001). It is
important to note the source of competitive advantage of a company
for the value chain analysis. The competitive advantage for IBM, for
example, lies in depth, breadth and the geographic spread of its global
operations (Rai, 2006) and the loyalty that the big blue enjoys from its
clientele.
Lastly, analysts should look for the managerial implications that the
new era of capability outsourcing may bring. The value chain decisions
of companies will increasingly shape their organisational structure.
Furthermore these decisions will determine the types of managerial
skills that companies may need to develop to survive in an increasingly
competitive business environment.

Where to find information for Value Chain Analysis

Analysts can explore various sources to find information necessary for
conducting the value chain analysis. Up to three years of annual
reports of the company can be analysed to see how the costing of the
activities are changing over the period and whether they are in unison
with the competitive strategy of the firm. These annual reports of the
company can be compared to the annual reports of the key
competitors in order to see how competitive strategies differ between
the companies, along with finding the difference in the contribution of
activities to the company’s profitability.
In order to gain knowledge about the core competence of the
company, analysts can look at the company and competitor websites.
SWOT analysis of the companies done by companies like Datamonitor
etc. can help the analyst to understand the key strengths and
weaknesses of the company and how the firm differs from its
competitors. Furthermore, journal articles, trade publications and
magazines are useful sources of information to identify how value is

7
created in the particular industry in which the company operates and
which activities play a key role in the generation of that value.

Limitations of Value Chain Analysis

One of the limitations of the value chain model is that it describes an

industrial organization which essentially buys raw materials and
transforms these into physical products. Notably, at the time when the
model was introduced (Porter, 1985), service industries in the western
countries employed lesser workforce compared to today’s statistics of
the same (www.wikipedia.org). Academics and practitioners alike have
critiqued the model and its applicability in the context of service
organisations. Partnerships, alliances and collaboration along with
differentiation and low costs are common drivers of value today.
The limitations of the model include the fact that ‘value’ for the final
customer is the value only in its theoretical context (Svensson, 2003),
and not practical terms. The real value of the product is assessed when
the product reaches the final customer, and any assessment of that
value before that moment is only something that is true in theory.
Despite this limitation, analysts can effectively use the value chain
model to determine the value to the final customers in a theoretical
way. Use of other planning tools and techniques like Porter’s generic
strategies, analysis of critical success factors etc. is recommended in
conjunction with the value chain framework for a more comprehensive
analysis of a company’s strategy and planning.

Conclusion
The value chain framework has been used as a powerful analysis tool
for organisational strategic planning for nearly two decades now. The
value chain framework shows that the value chain of a company may
be useful in identifying and understanding crucial aspects to achieve
competitive strengths and core competencies in the marketplace. The
model also reveals how the value chain activities are tied together to
ultimately create value for the consumer. The five primary activities
and four support activities form an interdependent system that is
connected by linkages. Analysts conducting the value chain analysis
should break down the key activities of the company according to the
activities entailed in the framework, and assess the potential for
adding value through the means of cost advantage or differentiation.
Finally, it is important to determine strategies that focus on those
activities that would enable the company to attain sustainable

8
competitive advantage.

It is important to analyse the value chain of a company with the core

competence at its very heart. The nature of value chain activities
differs greatly in accordance with the types of companies and
industries. The value chains of companies have undergone many
changes in the last two decades due to advancements in technology
facilitating change at a very rapid pace in the business environment.
Outsourcing will cause major changes in organisations and their value
chains, with significant managerial implications.
Sources for finding information on value chain analysis include three
years annual reports of the particular company and its key
competitors, company websites, journal articles, and other reputed
trade magazines etc. Use of other planning tools and techniques like
Porter’s generic strategies, analysis of critical success factors etc. is
suggested in conjunction with the value chain framework for a more
comprehensive analysis of a company’s strategic planning.

References
Ghamdi, S. M. Al (2005), The Use of Strategic Planning Tools and
Techniques in Saudi Arabia: An Empirical study, International Journal of
Management, Vol. 22, No. 3, p. 376-395.
Gottfredson, M. & Puryear, R. & Phillips, S. (2005), Strategic Sourcing
From Periphery to the Core, Harvard Business Review, Vol. 83, No. 2, p.
132-139.
Hill, W. L. C. & Jones, R. G. (2007), Strategic Management: An
Integrated Approach, 7th ed., Houghton Mifflin Company, Boston: New
York.
Lynch, R. (2003), Corporate Strategy, 3rd ed., Prentice Hall Financial
Times.
Macmillan, H. & Tampoe, M. (2000), Strategic Management, Oxford
University Press.
Magretta, J. (2002), Why business models matter, Harvard Business
Review.
Moore, G. A. (2005), Strategy and your stronger hand, Harvard Business
Review.
Pathania-Jain, G. (2001), Global parents, local partners: A value-chain
analysis of collaborative strategies of media firms in India, Journal of
Media Economics, Vol. 14, No. 3, p. 169-187.
Pearson, G. (1999), Strategy in Action, Prentice Hall Financial Times.
Porter, M. E. (1985), Competitive Advantage: Creating and Sustaining
Superior Performance, New York: Free Press.

9
Porter, M. E. (1990), The competitive advantage of nations, New York:
Free Press.
Rai, S. (2006), India becoming a crucial cog in the machine at IBM, The
New York Times.
Rainbird, M. (2004), A framework for operations management: the
value chain, International Journal of Physical Distribution & Logistics
Management, Vol. 34, No. 3/4.
Svensson, G. (2003), Consumer driven and bi-directional value chain
diffusion models, European Business Review, Vol. 15, No. 6, p. 390-400.

Thompson, A. A. & Strickland, J. A. (2003), Strategic Management:

Concepts and Cases, Thirteenth ed., McGraw-Hill.
Wikipedia, The free encyclopaedia, [Accessed on 6/10/06]

10