Demystifying Porter’s Value Chain Model: A Simple Explanation

Have you ever wondered how businesses create value and make profit? Understanding a company’s value chain can help explain how In this article, we’ll break down Porter’s value chain model in simple terms to help you understand the basics

What Exactly Is a Value Chain?

A value chain refers to the full range of activities that a company uses to create value and competitive advantage Essentially, it’s the process of turning inputs into outputs that customers want to buy

The value chain concept was developed by Michael Porter in his 1985 book Competitive Advantage. Porter realized that businesses gain strategic and competitive advantage by performing certain activities better than competitors. The value chain model helps identify and analyze these strategically important activities.

At its core, Porter’s value chain is about maximizing value creation while minimizing costs. Companies that excel at one or more points in the value chain can create competitive advantages over rivals.

Porter’s Value Chain Model Broken Down

According to Porter, the value chain model consists of primary and support activities:

Primary Activities

There are 5 key primary activities that contribute to value creation:

• Inbound logistics – receiving, warehousing, inventory control, transportation planning

• Operations – production planning, quality control, equipment maintenance

• Outbound logistics – order processing, warehousing, transportation operations

• Marketing and sales – promotion, pricing, channel management, sales force support

• Service – installation, maintenance, customer service, complaint handling

Each of these primary activities adds value to the product or service in its own way, such as making it more usable, accessible, visible, attractive to buyers, or post-sale services.

Support Activities

There are also 4 key support activities that make the primary activities more effective:

• Firm infrastructure – IT systems, financial management, quality management, executive leadership

• Human resource management – recruiting, training, compensation, performance management

• Technology development – research and development, process automation, technology upgrades

• Procurement – sourcing raw materials, negotiating prices, vendor management

Support activities provide the foundation for smooth operations in primary activities. For example, efficient procurement of materials leads to more efficient inbound logistics.

Here is a visual representation of Porter’s value chain model:

![Porter’s Value Chain Model][]

Porter’s original value chain model

As you can see, primary activities form the backbone of operations while support activities reinforce them from behind the scenes.

Now let’s explore each of these activities in more detail.

Primary Activities Explained

Primary activities involve the direct flow of production from raw materials to finished goods. Let’s break them down:

Inbound Logistics

Inbound logistics cover the activities needed to receive, handle, and store inputs. For a manufacturing company, this includes procuring raw materials, handling inventories, and maintaining relationships with suppliers. For a service company, it involves acquiring resources needed to perform the service.

Efficient inbound logistics help minimize costs and waste while maximizing quality. Companies can gain advantage by smart sourcing, bulk discounts, strategic supplier partnerships, and use of technology like barcode scanners or inventory software.

For example, Walmart pioneered an automated reordering system that helped reduce storage costs and avoid out-of-stock situations in stores.

Operations

Operations involve the transformation of inputs into final products or services. In manufacturing, this includes activities like machining, packaging, testing, printing, and facility maintenance. For service firms, operations involve delivering the service to customers.

Excelling in operations can mean better quality control, faster processing times, or ability to handle larger volumes. Companies can also gain advantage through innovation in production methods, use of advanced technology, or ability to offer more customization.

For instance, Apple contracts high-quality component manufacturers to make customized parts to their exact specifications. This allows them to deliver cutting-edge products and maintain tight quality control.

Outbound Logistics

Outbound logistics cover the activities needed to transport finished goods to customers. Warehousing, order processing, transportation, distribution management all fall under outbound logistics.

Advantages can be gained through lower storage costs, faster order fulfillment, reduced product damage, and strategic distribution partnerships.

For example, Amazon built a vast network of warehouses and logistics infrastructure that allows fast shipping times at low costs. This was a key factor in their e-commerce dominance.

Marketing and Sales

Marketing and sales activities inform buyers about products, promote them, and facilitate transactions. Market research, advertising, pricing, channel selection, sales management, and order processing all fall under this activity.

Competitive advantages come from targeted marketing campaigns, recognizable branding, appropriate pricing strategies, wide distribution coverage, and motivated sales teams.

Coca Cola, for instance, distributes their products worldwide through bottlers, vending machines, restaurants, and many retail channels. Their omnipresent marketing also keeps the brand top-of-mind.

Service

Service activities enhance product performance after sale. This includes installation, maintenance, repairs, training, parts supply, and handling complaints. Good after-sales service provides value by extending useful product lifetime.

Companies can stand out by offering superior customer support, service level agreements, user training services, and performance guarantees. Offering specialized services related to their product can also create advantage.

For example, KitchenAid differentiates themselves by offering cooking classes to educate customers on using their kitchen appliances.

Support Activities Explained

Now let’s explore the key support activities that make primary activities more effective:

Firm Infrastructure

Infrastructure supports day-to-day operations through broad business functions. This includes general management, legal, finance, accounting, public relations, quality management, and IT systems.

Efficient infrastructure reduces operational costs and facilitates coordination between departments. Companies can gain advantage through effective strategic planning, performance measurement systems, and strong company culture.

For example, Nike has a fast turnaround in their design-to-delivery cycle by maintaining an agile corporate structure.

Human Resource Management

HR activities ensure you have the right people undertaking primary activities. This covers recruiting, hiring, training, compensation, performance appraisals, and workplace culture.

Advantages come from having motivated, skilled employees. Leading companies invest in people analytics, employee training programs, and creating a positive work environment.

Starbucks gained advantage by offering employee stock options and benefits even to part-time workers, reducing turnover.

Technology Development

Technology activities apply scientific and technical knowledge to improve production processes and product design. R&D, process mechanization, and technology upgrades occur in this activity.

Companies can gain advantage through proprietary technology, patented production methods, and better product performance through innovation.

For example, 3M regularly allocates a high percentage of revenue to R&D, resulting in many innovative products over the years.

Procurement

Procurement involves sourcing and handling inputs from suppliers. Vendor selection, negotiation, ordering, and payment systems are key procurement tasks.

Advantages can come from lower material costs, better quality inputs, and improved supplier relationships through effective procurement methods.

Walmart, for instance, uses its enormous purchasing power to pressure suppliers for lower prices, contributing to their low-cost advantage.

Analyzing a Company’s Value Chain

The value chain framework helps identify potential sources of competitive advantage within a company’s value-creating activities.

Here are some key strategic questions to consider when analyzing your value chain:

• Which primary activities contribute most to customer value creation? Which most impact costs?
• What resources, capabilities and technologies do we need to support primary activities?
• How can we better integrate activities between departments?
• Where can we use technology or automation to maximize efficiency?
• Where can supplier relationships be improved to increase bargaining power?
• Which support activities can be streamlined to reduce costs?
• Which areas need investment to improve product differentiation?

The goal is to identify activity areas with the most potential for value creation and cost reduction. Activities that fit with company strengths and capabilities are prime candidates for investment and improvement.

Benchmarking against other companies can reveal performance gaps and opportunities. Primary activities with weak performance compared to rivals are priorities for enhancement or re-engineering.

While the value chain model is most applicable to manufacturing firms, the basic principles can be adapted to analyze service businesses, online companies, non-profits, and governmental entities. The key is determining their main operations, supporting infrastructure, and sources of competitive advantage.

Value Chain vs. Supply Chain

The terms “value chain” and “supply chain” are sometimes used interchangeably. But there are important differences:

• The value chain analyzes internal activities of a single company. The supply chain covers the interconnected activities across multiple firms that deliver value to customers.
• The value chain focuses on competitive advantage for a single company. The supply chain considers how interconnected companies can optimize the whole system.
• The value chain model views suppliers as outside the company’s value creation process. The supply chain model considers suppliers