What is the value chain? - GovtVacancy.Net

What is the value chain?

A value chain is a strategic tool used to analyze the activities of a company and thus identify its sources of competitive advantage. From a brief bibliographic review, the concept and its usefulness will be expanded.

Origin of the concept

The value chain concept began to become popular around 1985 with the publication of the book The Competitive Advantage: Creating and Sustaining Superior Performance, by Professor Michael Porter, who was based on the idea of ​​business systems, developed by the firm McKinsey & Co. at the beginning of the same decade.

McKinsey's proposal considered the company as a series of functions, marketing, human resources, production, etc., which should be analyzed in relation to the same functions of competing firms if what was wanted was to understand their strategy and know their position in the market.

Porter went beyond this concept of broad functional levels by breaking them down into their individual activities, further adding that the sources of competitive advantage, low-cost leadership, and differentiation, proposed in  Competitive Strategy: Techniques for Analyzing Industries and Competitors (1980), depended on these individual activities. Thus, through this disaggregation, the value chain provided the firm with the capabilities to understand its costs and to identify its existing or potential sources of differentiation.

what is value

The value chain is based on the concept that the company must create value in the products and services it offers its customers, so it is worth asking what it is or what that value refers to.

A fundamental concept of Porter's theory is that of margin. The margin is the value that the company's products and services have from the customers' point of view, with fewer costs.

Porter (p.54) indicates that, from the point of view of competition, value is what people are willing to pay for what is offered. Value is measured by total revenue, a reflection of the price charged for the product and the units it manages to sell. A company is profitable if its value exceeds the costs of creating its product. The goal of a generic strategy is to generate value for buyers that exceeds its cost. Value, not cost, should be used when analyzing the competitive position, as companies often intentionally increase costs to obtain a higher price through differentiation.

Mintzberg, Quinn, and Boyer (p.90)  explain it this way: the value of a product or service is measured based on the amount that the buyer is willing to pay, in other words, a price. Porter calls the company's network of activities a value chain because it seeks to transform low-cost inputs into products or services with a price above their costs. The excess of prices over costs is called the margin.

What is the value chain?

The value chain is the basic business tool to analyze the sources of competitive advantage, it is a systematic means that allows examining all the activities that are carried out and their interactions. It allows dividing the company into its strategically relevant activities in order to understand the behavior of costs, as well as current and potential sources of differentiation. (Porter, p.51)

The value chain is a strategic analysis tool that helps determine the foundations of a company's competitive advantage, through the orderly disaggregation of all the company's activities. (Garralda, p.1)

The value chain provides a general application model that allows for systematically representing the activities of any organization, whether isolated or part of a corporation. It is based on the concepts of cost, value, and margin. The value chain is made up of a series of value-adding stages, of general application in production processes. The value chain provides a coherent scheme to diagnose the position of the company with respect to its competitors and a procedure to define the actions aimed at developing a sustainable competitive advantage. (Quintero and Sánchez, p.381)

The concept of the value chain consists of the fragmentation of the company's activities into a set of differentiated tasks, called value-adding activities. These activities can be divided into two large groups: primary activities and support activities. Primary activities are those that involve the physical creation of the product or service and its subsequent sale or transfer to the buyer. Support activities support the primary activities and support each other by providing purchased inputs, technology, and human resources. Each of the main activities is comprised of generic categories. (Troncoso, p.24)

How is a generic value chain constituted?

A value chain is made up of nine generic categories of activities that are integrated into characteristic ways. With the generic chain, it is shown how a value chain can be built, reflecting the activities it carries out. Likewise, it shows the way in which the activities of which it consists are connected to each other and to those of suppliers, channels, and buyers, also indicating how these links affect competitive advantage. (Porter, p.52)

Porter divides the foundations of organizational functioning into two types of activities: primary and support. The primary activities are internal logistics, operations, external logistics, marketing, and sales and service. These activities are primary because they add value directly, for example, through a better quality product, lower production costs, or even after-sales services, inducing buyers to pay a higher price. Support activities include sourcing, technology development, human resource management, and company infrastructure. Unlike primary activities, supporting activities do not add value directly, but instead, enhance the ability of primary activities to add value. (Mintzberg, Quinn and Boyer, p.91)

McLeod (p.37)  explains the "mechanism" of the value chain thus:

Companies create value by performing activities, which Porter calls value activities. Value activities fall into two main categories: primary and supportive. Primary value activities are those associated with producing and offering your customers greater value than your competitors. Value is produced by delivering goods and services to customers and providing support after the sale. Manufacturing and sales activities are good examples. Activities with supporting value provide the inputs and infrastructure that enable the primary activities to be carried out. The company's shareholder relations department, market research group, and accounting department are examples of organizational units that perform such support activities.

Primary and support value activities are integrated through links to form a value chain, as illustrated in the figure. The chain is shaped like an arrow, with a margin at its tip. Primary activities appear in the bottom layer and include inbound (internal) logistics, which obtains raw materials and supplies from suppliers; the company's operations, which transform raw materials into finished products; outbound (external) logistics that transport products to customers; marketing and sales operations that identify customer needs and obtain orders; and service activities that maintain good relationships with customers after the sale.

Activities with supporting value appear at the top layer where the infrastructure of the company is located: the organizational framework that influences all primary activities in general. Furthermore, there are three activities that can influence the primary activities individually or in combination. Human resource management consists of all those activities related to the control of company personnel, including the functions that managers perform and the roles they play. Technological development refers to all activities involving technology, including the effective application of technology. The creation of computer-based information systems is an example. Procurement (sourcing) is concerned with obtaining resources such as material and equipment, and those that the primary activities use. The company's purchasing department performs many of these procurement activities.

Every value activity, whether primary or supportive, contains three essential ingredients: purchased inputs, human resources, and technology. Also, each activity uses and creates information. For example, information specialists in the information services unit combine purchased commercial databases, leased computer equipment, and custom-written programs to produce decision-support information for company executives.

Quoting Porter again (p.56) :

Every value activity uses purchased inputs, human resources (labor and managers), and some kind of technology to fulfill its function. It also uses and generates information: customer data (reception of orders), performance parameters (tests), and product failure statistics. It can also give rise to financial assets (such as inventory and accounts receivable) or liabilities (such as accounts payable).

Value activities are divided into two large groups: primary and support. The former, which appear at the bottom of the figure, are those involved in the physical creation of the product, in its sale and transfer to the customer, as well as in post-sale assistance. In a signature, they can be divided into the five generic categories in the figure. Support activities support primaries and vice versa by providing inputs, technology, human resources, and various global functions. The dotted lines indicate that acquisitions, technology development, and human resource management can be associated with certain priority activities and at the same time support the entire chain. The infrastructure is not related to any primary activity but rather supports it.

Thus, value activities are the discrete structures of competitive advantage. How they are done, along with their economics, will determine whether a firm is at a high or low cost relative to the competition. The differences that govern competitive advantage are laid bare when rivals' value chains are compared.

Thank You