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Value chain The value chain developed by Michael Porter represents one of the first
serious attempts in the field of strategy to analyze customer need struc-
tures. Porter presented the value chain in his book Competitive Advantage,
published in 1985.
Value is defined in this context as what buyers are willing to pay for what
they get from suppliers. A company is profitable if the value it generates
exceeds the cost it has to pay for generating that value. Analysis of the
competitive situation must therefore be based not on cost, but on value.
According to Porter, a company’s competitive edge cannot be understood
simply by studying the company as a whole. A competitive advantage arises
out of the manifold activities which a company pursues in its design,
production, marketing, delivery and supporting functions. Each of these
activities can contribute to the company’s relative cost position and create
a basis for differentiation.
Porter places the corporate value chain in a greater stream of activities,
which he calls the value system; it is illustrated below.
Professor Michael Porter has drawn these two diagrams to illustrate the
value chain (also called the added value chain). It describes the addition of
value to a product from raw material and purchasing to the finished article.
By analyzing the process step by step, we can identify links in the chain where
we are competitive or vulnerable.
Su pp
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iti es
Raw material Components Finished products Sales
Corporate structure
Human resources
Technological development
Purchasing
Primary activities
Inb ou
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s
M an
uf ac
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g
Ou tb
ou nd
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M ar
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les
Se rv
ice
M argin
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Porter’s value system
Porter’s definition of value in a competitive context is the sum a buyer is
willing to pay for what a supplier delivers. Value is measured as total
revenue, which is a function of the price a company’s product fetches and
the number of units the company can sell.
Every value-generating activity involves:
• bought-in components.
• human resources.
• some form of technology.
• information flows of various kinds.
Value-generating activities can be divided into two classes:
1. Primary activities
2. Support activities
Primary activities are shown under the large arrow. They are the activi-
ties that result in the physical creation of a product and its sale, delivery
to the buyer, and the after-sales market.
1. Inbound logistics comprises reception, warehousing, sorting,
handling, buffer storage, stocktaking, transportation and back
deliveries.
2. Manufacturing comprises all activities that convert the inflow into
end products, such as machining, packaging, assembly, plant
maintenance and testing.
3. Outbound logistics comprises activities concerned with shipment,
warehousing and physical distribution of products to buyers. This
includes order processing, scheduling, deliveries, transportation,
and so on.
4. Marketing and sales comprises all activities designed to persuade
buyers to accept and pay for the product. This includes advertising,
sales promotion, personal selling, quotation writing, choice of
distribution channels and pricing.
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5. Service comprises all activities designed to maintain or enhance
the value of the product delivered. This includes installation,
repairs, training, spare parts and product modification.
Support activities are shown on the top four lines of the figure. They are:
1. Corporate structure, which embraces a number of activities
including management, planning, finance, accounting, legal
business, relations with the public sector and quality management.
2. Human resource management, which includes the recruitment,
training, development and remuneration of all categories of
personnel.
3. Technological development, which affects every value-generating
activity in the areas of know-how, procedures and processes.
4. Purchasing, which has to do with procurement of materials, that
is, the actual function of buying supplies, not the logistic flow of
materials.
RECOMMENDED READING
1. Kim B Clark et al, Harvard Business Review on Managing the
Value Chain.
2. Michael E Porter, Competitive Strategy: Creating and Sustaining
Superior Performance.
Vertical integration Vertical integration is an expression for the portion of value added that
is produced within the framework of common ownership. If a product is
sold, its price probably comprises the input costs of materials, components
and systems. If the price of buying this input is high, integration is low.
But if the major share of sales value is produced internally in one’s organ-
ization, integration is high. The term horizontal integration is used
considerably less often nowadays. It expresses the utilization of a wide
range of products to achieve maximum customer satisfaction.