A value chain is a series of consecutive steps that go into the creation of a finished product, from its initial design to its arrival at a customer’s door. The chain identifies each step in the process at which value is added, including the sourcing, manufacturing, and marketing stages of its production.
A company conducts a value-chain analysis by evaluating the detailed procedures involved in each step of its business. The purpose of a value-chain analysis is to increase production efficiency so that a company can deliver maximum value for the least possible cost.
Key Takeaways
- A value chain is a step-by-step business model for transforming a product or service from idea to reality.
- Value chains help increase a business’s efficiency so the business can deliver the most value for the least possible cost.
- The end goal of a value chain is to create a competitive advantage for a company by increasing productivity while keeping costs reasonable.
- The value-chain theory analyzes a firm’s five primary activities and four support activities.
Understanding Value Chains
Because of ever-increasing competition for unbeatable prices, exceptional products, and customer loyalty, companies must continually examine the value they create to retain their competitive advantage. A value chain can help a company to discern areas of its business that are inefficient, then implement strategies that will optimize its procedures for maximum efficiency and profitability.
In addition to ensuring that production mechanics are seamless and efficient, it’s critical that businesses keep customers feeling confident and secure enough to remain loyal. Value-chain analyses can help with this, too. The overarching goal of a value chain is to deliver the most value for the least cost in order to create a competitive advantage.
Background
Michael E. Porter of Harvard Business School introduced the concept of a value chain in his book Competitive Advantage: Creating and Sustaining Superior Performance. He wrote: “Competitive advantage cannot be understood by looking at a firm as a whole. It stems from the many discrete activities a firm performs in designing, producing, marketing, delivering, and supporting its product.”
In other words, it’s important to maximize value at each specific point in a firm’s processes.
Components of a Value Chain
In his concept of a value chain, Porter splits a business’s activities into two categories, “primary” and “support,” whose sample activities we list below. Specific activities in each category will vary according to the industry.
Primary Activities
Primary activities consist of five components, and all are essential for adding value and creating a competitive advantage:
- Inbound logistics include functions like receiving, warehousing, and managing inventory.
- Operations include procedures for converting raw materials into a finished product.
- Outbound logistics include activities to distribute a final product to a consumer.
- Marketing and sales include strategies to enhance visibility and target appropriate customers—such as advertising, promotion, and pricing.
- Service includes programs to maintain products and enhance the consumer experience—like customer service, maintenance, repair, refund, and exchange.
Support Activities
The role of support activities is to help make the primary activities more efficient. When you increase the efficiency of any of the four support activities, it benefits at least one of the five primary activities. These support activities are generally denoted as overhead costs on a company’s income statement:
- Procurement concerns how a company obtains raw materials.
- Technological development is used at a firm’s research and development (R&D) stage—like designing and developing manufacturing techniques and automating processes.
- Human resources (HR) management involves hiring and retaining employees who will fulfill the firm’s business strategy and help design, market, and sell the product.
- Infrastructure includes company systems and the composition of its management team—such as planning, accounting, finance, and quality control.
Real-Life Examples of Successful Value Chains
Starbucks Corporation
Starbucks offers one of the most popular examples of a company that understands and successfully implements the value-chain concept. Numerous articles discuss how Starbucks incorporates the value chain into its business model.
Trader Joe’s
Another example is the privately-held grocery store Trader Joe’s, which has received much press about its tremendous value and competitive edge. When you enter a Trader Joe’s store, you can readily observe instances of the business that reflect the five primary activities of the value chain:
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Inbound logistics. Unlike traditional supermarkets, Trader Joe’s does all of its receiving, shelving, and inventory-taking during regular store hours. Although it may be maddening for shoppers, this system creates significant cost savings in terms of employee wages alone. The logistics of having this work take place during shopping hours conveys the strategic message that “we’re all in this together.”
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Operations. In the supermarket industry, converting raw materials into finished products may not apply directly. Instead, we can look at “product development” as an essential operation at Trader Joe’s. The company selects its products carefully, featuring unique items often unavailable elsewhere. Its private-label products account for over 80% of its offerings, ensuring higher profit margins through efficient volume sourcing. Additionally, taste-testing and chef-partnership programs ensure product quality and refinement.
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Outbound logistics. Although Trader Joe’s does not offer home delivery like many other supermarkets, it focuses on creating a pleasant onsite experience. This includes in-store tastings, where shoppers can sample both new and familiar items, contributing to a lively atmosphere.
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Marketing and sales. Trader Joe’s relies more on its in-store experience and less on traditional marketing strategies. The unique branding, product labels, and overall shopping environment serve as marketing tools, attracting its specific customer base. This indirect marketing helps differentiate Trader Joe’s and sharpen its competitive edge.
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Service. Customer service is paramount at Trader Joe’s. The abundance of friendly and knowledgeable staff ensures that shoppers always feel attended to. The company’s no-questions-asked refund policy also enhances customer satisfaction.
Trader Joe’s has successfully applied value-chain theory, making it a prime example of the value chain in action.
This list could go on and on before ever reaching the four support activities cited above, as Trader Joe’s is a wildly successful example of applying value-chain theory to its business.
Related Terms: Business Model, Operation Management, Production Optimization, Competitive Edge.
References
- Michael E. Porter. “Competitive Advantage: Creating and Sustaining Superior Performance”. Simon and Schuster, 2008.
- Trader Joe’s. “Home”.
