Information about Value Chain

The value chain, also known as value chain analysis, is a concept from business management that was first described and popularized by Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and Sustaining Superior Performance.

A value chain is a chain of activities. Products pass all activities of the chain in order and at each activity the product gains some value. The chain of activities gives the products more added value than the sum of added values of all activities. It is important not to mix the concept of the value chain, with the costs occurring throughout the activities. A diamond cutter can be used as an example of the difference. The cutting activity may have a low cost, but the activity adds to much of the value of the end product, since a rough diamond is a lot less valuable than a cut diamond.

The value chain categorizes the generic value-adding activities of an organization. The "primary activities" include: inbound logistics, operations (production), outbound logistics, marketing and sales, and services (maintenance). The "support activities" include: administrative infrastructure management, human resource management, R&D, and procurement. The costs and value drivers are identified for each value activity. The value chain framework quickly made its way to the forefront of management thought as a powerful analysis tool for strategic planning. Its ultimate goal is to maximize value creation while minimizing costs.

The concept has been extended beyond individual organizations. It can apply to whole supply chains and distribution networks. The delivery of a mix of products and services to the end customer will mobilize different economic factors, each managing its own value chain. The industry wide synchronized interactions of those local value chains create an extended value chain, sometimes global in extent. Porter terms this larger interconnected system of value chains the "value system." A value system includes the value chains of a firm's supplier (and their suppliers all the way back), the firm itself, the firm distribution channels, and the firm's buyers (and presumably extended to the buyers of their products, and so on).

Capturing the value generated along the chain is the new approach taken by many management strategists. For example, a manufacturer might require its parts suppliers to be located nearby its assembly plant to minimize the cost of transportation. By exploiting the upstream and downstream information flowing along the value chain, the firms may try to bypass the intermediaries creating new business models, or in other ways create improvements in its value system.

The Supply-Chain Council, a global trade consortium in operation with over 700 member companies, governmental, academic, and consulting groups participating in the last 10 years, manages the de facto universal reference model for Supply Chain including Planning, Procurement, Manufacturing, Order Management, Logistics, Returns, and Retail; Product and Service Design including Design Planning, Research, Prototyping, Integration, Launch and Revision, and Sales including CRM, Service Support, Sales, and Contract Management which are congruent to the Porter framework. The "SCOR" framework has been adopted by hundreds of companies as well as national entities as a standard for business excellence, and the US DOD has adopted the newly-launched "DCOR" framework for product design as a standard to use for managing their development processes. In addition to process elements, these reference frameworks also maintain a vast database of standard process metrics aligned to the Porter model, as well as a large and constantly researched database of prescriptive universal best practices for process execution.

A value chain reference model (VRM) has been developed by the Value Chain Group to offer de facto standard for value chain management encompassing one unified reference framework representing the process domains of product development, customer relations and supply networks called the Value Reference Model, or VRM. VRM is the next generation Business Process Management that extends the Supply Chain processes of Acquire, Build, Fulfill and Support to include Market, Research, Develop, Brand, Sell and Support. The three centers of excellence are product excellence, operations excellence, and customer excellence.

When not to apply The Value Chain

Porter's basic model describes an industrial organization buying raw materials and transforming these into physical products.

In 1985, when Porter introduced the Value Chain, around 60% of most western economies' workforces were active in service industries. In 2006, most service industries in western countries employ over 80% of the workforce.

Critique on the Value Chain model and its applicability to services organizations has since been voiced by both academics and practitioners. See for example (Peppard and Rylander, 2007) and (Van Middendorp, 2005). Porter's focus on 'either or' strategies and competition as the main driving force in any industry, are not that well suited to the complexity of most industries today. Collaboration in addition to competition and differentiation in addition to low cost are common drivers. Furthermore, Porter is focused on the tangible outcomes of cost, revenue, margin and basic configuration of business activities. The Value Network may be the mental model that embraces the linear Value Chain Model and that adds an extra dimension for those seeking to make sense of complexity as we see it in organizations and their environment today.

Further Developments in Value Chain Research

More recently, the term value grid has been developed to highlight the fact that competition in the value chain has been shifting away from the strict linear view defined by the traditional 'value chain' model (Pil and Holweg, 2006).

The value chain in its original sense was defined as a sequence of value-enhancing activities. In its simplest form, raw materials are formed into components, which are assembled into final products, distributed, sold, and serviced. Frequently, the activities span multiple organizations. This orderly progression of activities allows managers to formulate profitable strategies and coordinate operations.

However, it can also put a stranglehold on innovation at a time when the greatest opportunities for value creation (and the most significant threats to long-term survival) often originate outside the traditional, linear view. Traditional value chains may have worked well in landline telecommunications and automobile production during the last century, but today innovation comes in many shapes and sizes—and often unexpectedly.

Pil and Holweg hence argue for seeing value creation as multidirectional rather than linear. Given the constant tension between opportunity and threat, firms need to explore opportunities for managing risks, gaining additional influence over customer demand, and generating new ways to create customer value. Nokia, for example, is legendary for having the foresight to lock in critical components that were in short supply, allowing it to achieve significant market share growth. However, a few years ago it suffered a setback when competitors used the same strategy to take advantage of shifts in the demand for LCD displays.

Protection against such fickle reversals calls for a more complex view of value—one that is based on a grid as opposed to the traditional chain. The grid approach allows firms to move beyond immediately recognizable opportunities and across industry lines. This permits managers to identify where other companies—perhaps even those engaged in entirely different value chains—obtain value, line up critical resources, or influence customer demand. The new paths can be vertical; horizontal; and even diagonal. Successful managers need to learn how to assemble multi-faceted value grids that leverage new opportunities and respond to new threats.

References

Pil, F.K. and Holweg, M. (2006) "Evolving from value chain to value grid." MIT Sloan Management Review, 47(4): 72-80

Michael E. Porter (1985) Competitive advantage: creating and sustaining superior performanceP33 The Free Press

See also

• Porter generic strategies
• Porter 5 forces analysis
• Marketing strategy
• Buzzword
• Strategic management
• Value migration
• Value
• Value network
• Value shop
• Calculating Demand Forecast Accuracy