What is Value Chain Analysis?
The value chain of a business is an operations map that is designed to identify the linkages between different activities and processes.
Business operations are all the activities, systems, and processes that a business utilizes to keep running on a daily basis.
The definition, like the term, must ultimately be vague.
The operations required to keep a hospital running, for example, are quite different from the processes an auto mechanic relies on to keep her shop in running order.
Although you can be as granular as you’d like in defining operational roles and responsibilities, ultimately operations revolve around the delivery of value to customers.
Value is the reason any company—big or small—exists.
It is also the economic how and why of a venture’s success. We know that the amount of money that a company is left with once they have collected their revenues and deducted their costs is that company’s margin of profit.
This is the amount that “goes in the bank,” so to speak. In his 1985 book Competitive Advantage Michael Porter suggested a different, value-centric way to describe a firm’s profit margin:
Value Created and Captured – The Cost of Creating that Value = Profit Margin
The value equation that Michael Porter put forward in his book Competitive Advantage. This value-centric approach is a core element behind the value chain analysis process.
This high-level formula is foundational to understanding the concept of a value chain and to mapping and interpreting your own venture’s value chain.
Additionally, because value and profit are so closely aligned, it behooves entrepreneurs (and decision-makers of all levels) to study their ventures from a value-centric viewpoint.
Understanding The Value Chain: Primary Vs. Support Activities
The breakeven formula is used to calculate the point at which revenues equal costs, known as the breakeven point. It is the point at which a business “breaks even,” or recovers the amount of money that has been put into the business.
Primary activities relate directly to the creation, sale, maintenance, and support of a product or service. Primary activities are classified very broadly:
Inbound Logistics: These processes involve receiving, storing, and distributing inputs internally. Strong supplier relationships are often an opportunity to create value in this area.
Operations: These are the meat of your business where inputs are changed into outputs. These outputs could be physical, in the way that manufacturers transform raw materials into finished goods, or they could be less tangible, such as the processes, knowledge, and equipment that service providers use to execute services.
Outbound Logistics: These are the activities that deliver your product or service to your customer—things like warehousing, distribution, and service delivery. The processes that make up an organization’s outbound logistics can be a mix of internal and external activities (and often are).
Marketing and Sales: Marketing and sales activities refer to the ways in which your organization persuades customers to choose your products or services over those of a competitor.
Service: Service activities include everything related to the post-purchase value maintenance of your product or service to your customers.
Support activities feed into one or more of the primary activities, and, as the name implies, they do not take a leading role indirectly creating value for customers. Support activities include the following:
Firm Infrastructure: These elements are an organization’s support systems, such as the accounting, administrative, general management, and legal departments.
Human Resource Management: These support activities include everything from recruitment and hiring practices to training and compensation of staff members.
Technology Development: This encompasses everything an organization does to innovate and keep pace with technological trends.
Procurement: This includes all of the activities involved in purchasing the resources needed to operate on a daily basis. Here, quality control and price negotiation are drivers of value.
Primary and support activities come together to form the entire value chain map—a directional process.
Notice the dashed leaders that extend from the primary activities into the support activities.
This is designed to demonstrate and agitate the concept that support activities directly feed into primary activities. As business processes transform inputs into outputs, value is created for customers.
Note: So far, we have mapped a generic value chain that is largely theoretical.
For entrepreneurs who are designing their operations from the ground up or looking for ways to add more value to existing operations, this map is not the final result of your efforts, but a structured tool.
Instead of staring at an empty whiteboard or a blinking cursor, Porter’s value chain model represents a path to better understanding the creation of value within your venture.
To put it another way, do not investigate your operations strategy to create this map—rather, create this map to investigate your operations strategy.
In just a moment we’ll get to an example of a value chain map in action, but first, there is one more granular level of activity classification.
We have already looked at the macro-level classifications that categorize activities (inbound logistics, firm infrastructure, marketing and sales, etc.). Now let’s identify the individual activities that make up these categories.
Activities are one of three types:
Direct Activities: These are sub-activities that create value by themselves. For example, in a retailer’s inbound logistics primary activity, unloading new merchandise to replenish shelves is a direct sub-activity—shoppers can’t find the items they are searching for on empty store shelves.
Indirect Activities: These are sub-activities that allow direct activities to run smoothly.
For example, to ensure that a retailer’s direct activity of unloading new merchandise goes smoothly, certain indirect activities must be performed, such as managing the receiving staff and ensuring that new items are properly entered into inventory before going to the sales floor.
Quality Assurance Activities: These sub-activities ensure that direct and indirect activities meet the organization’s standards.
For the retailer’s inbound logistics primary activity, quality assurance sub-activities could include inventory double-checking procedures to confirm the contents of the order.
Evaluating Your Value Chain
Evaluation of your value chain consists of three steps:
Activity Analysis: Start by identifying the scope of activities needed to deliver your product or service.
Value Analysis: For each activity uncovered in the previous step, identify the ways in which it contributes to the value you provide for your target customers.
Evaluation and Planning: If you are analyzing an existing value chain, examine each activity and look for ways to increase the impact of that activity on the value you deliver.
Keep in mind that a value chain analysis is a robust tool to give a better understanding of the operations of an existing business, as well as a useful tool to plan operations for a business that does not yet exist.
This structured approach forces business planners and decision-makers to carefully examine every facet of their business from a strategic operations perspective. Not sure where to start? In some cases, it may be easier to work backward, moving right to left along the value chain map.
The Bottom Line
Value chain analysis isn’t a silver bullet that will fix all of the problems that might be plaguing your business. It is, however, a good exercise to figure out the best way to leverage efficiencies within your business.
Don’t execute a value chain analysis simply because it is something you think an entrepreneur, business owner, or decision-maker should do. Execute one to explore your business, learn from linkages, and act upon the insight it generates.