Value Chain

What is a Value Chain?

A value chain is all the activities and processes within a company that help add value to the final product. In today’s business landscape, companies across all industries are now more competitive than ever before.

Advancements in technology have made it easier for companies to take advantage of economies of scale and react quickly to the changing preferences of consumers. The goal of most companies is to gain a competitive advantage in the market by increasing value and lowering costs. The value chain method is a way to identify the best path to enhance value for the customer.

Value Chain Analysis

In the 1980s, Michael Porter introduced a technique known as value chain analysis, which has since become a useful tool for companies to help gain a competitive advantage. Value chain analysis is a focus on the internal activities of a business to gain an understanding of the costs of the business and how different activities can add value to its product. The analysis focuses on the primary functions of a business, such as:

• Inbound logistics: Receiving, storing, and distributing the inputs or raw materials. Here, your relationship with suppliers is vital.
• Operations: All the activities that go into transforming the inputs into outputs that are then sold to consumers. Modifications to this step can help add value to the final product.
• Outbound logistics: Getting your product to the final consumer – the delivery and distribution phase.
• Marketing and sales: Efforts taken by the business to make the consumer aware of the product.
• Service: Activities that maintain the value of the product or service after it is sold to the customer.

In addition to the five primary activities, there are also secondary activities that support the operations within certain primary activities. They include:

1. Firm infrastructure
2. Human resource management
3. Technological development
4. Procurement

How to Implement the Value Chain

Porter’s generic strategies for the value chain can be used for any industry across the board. The three-step process is as follows:

1. Identify the secondary activities for each primary activity

Each primary activity has secondary activities associated with it. A company needs to decide which of these activities add the most value. The three sub-activities include:

• Direct activities – Activities that individually help create value. For a business that sells chocolate, marketing and promotions and online sales help create value for the product.
• Indirect activities – Activities that help direct activities function more smoothly. They include human resources management and accounting.
• Quality assurance – Ensures that direct and indirect activities meet the required standards and follow compliance.

2. Identify the secondary activity for each support activity

Support activities such as accounting and human resources determine the sub-activities that provide value to the primary activities. For example, how does accounting add value to a primary activity such as operations or logistics?

3. Identify a connection between the activities

The next step and probably the most challenging one is to identify the links between all the activities. The connections are key to gaining a competitive advantage in the industry. There can be a connection between the amount of human capital investment in an accounting firm and the amount of debts outstanding.

Advantages of Value Chains

Value chains help break down all the activities that go into producing a good or service and understanding areas of cost savings and differentiation. With a value chain, you can optimize efforts, eliminate waste, and improve profitability. The value chains help provide useful insights that can bring greater value to the end customer.

For example, you may find that a product can be produced at a lower cost by a subsidiary firm. In such a case, the company should outsource the production of the product to the subsidiary firm. The lower cost can then be passed on to the consumer as lower prices, which can help differentiate the product in the market and achieve a competitive advantage.

More Resources

Thank you for reading CFI’s guide to Value Chain. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:

• Forward Integration
• Logistics
• Quality of Inventory
• Value Change
• See all accounting resources