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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.

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Raw material Components Finished products Sales

Corporate structure

Human resources

Technological development

Purchasing

Primary activities

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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.