Porter's Value Chain Explained
Summary
TLDRPorter's Value Chain is a strategic tool that maps internal business activities to understand how they add value to customers. It includes primary activities like operations and marketing, and support activities like HR and technology development. By analyzing these activities, businesses can maximize their margin and competitive advantage. The tool, developed by Michael Porter, helps organizations identify areas for investment and eliminate non-value-adding activities, ultimately increasing efficiency and profitability.
Takeaways
- 🍽️ Porter's Value Chain is a strategic tool used to map internal business activities that add value to customers.
- 👨🍳 The example of a chef cooking a meal illustrates how value is added beyond the cost of raw ingredients.
- 💹 The difference between the sales price of a product and the cost of creating it is known as margin.
- 🔍 The purpose of the value chain is to understand activities that create value or margin to enhance competitive advantage.
- 📚 Developed by Michael Porter, the concept is detailed in his book 'Competitive Advantage'.
- 🔗 The value chain is divided into primary activities (directly developing inputs into outputs) and support activities (facilitating primary activities).
- 📊 Primary activities include inbound logistics, operations, outbound logistics, marketing and sales, and service.
- 🛠️ Support activities encompass procurement, human resource management, technology development, and firm infrastructure.
- 🔍 Mapping your own value chain involves identifying sub-activities, analyzing their value creation, and examining interactivity between activities.
- 🌟 The value chain can be used for strategic planning, ensuring complete coverage in change initiatives, and assessing acquisition fit.
- 🚀 Amazon's AWS is an example of leveraging a core competency (web hosting) to create a new service, demonstrating the value chain's utility in identifying opportunities.
Q & A
What is Porter's Value Chain?
-Porter's Value Chain is a strategic tool that helps map out the internal business activities that add value to customers. It's a way to understand the activities within a business that create value or margin, which can then be optimized to improve competitive advantage.
How does a chef's cooking process relate to the concept of value addition in Porter's Value Chain?
-A chef's cooking process exemplifies value addition by creating a meal that is worth more than the sum of its raw ingredients. This is analogous to businesses creating value by transforming inputs into outputs that customers are willing to pay a premium for, thus generating a margin.
What is the significance of the margin in the context of the value chain?
-The margin in the context of the value chain refers to the difference between the sales price of a product or service and the cost of creating that output. Understanding and optimizing this margin is key to enhancing a business's profitability and competitive position.
How does the value chain help in identifying areas for investment and cost reduction?
-The value chain helps by breaking down all the activities an organization performs into primary and support activities. By analyzing these activities, businesses can identify which ones add more value than they cost and focus on investing in those, while eliminating or streamlining those that do not contribute positively to the margin.
What are the primary activities in Porter's Value Chain?
-Primary activities in Porter's Value Chain are those that directly contribute to the creation of a product or service. They include inbound logistics, operations, outbound logistics, marketing and sales, and service.
Can you explain the role of support activities in the value chain?
-Support activities in the value chain facilitate the smooth operation of primary activities. They include procurement, technology development, human resource management, and firm infrastructure. These activities provide necessary support across the entire value chain, helping to maintain efficiency and effectiveness.
How does the value chain model differ from traditional accounting cost analysis?
-The value chain model differs from traditional accounting cost analysis by focusing on the process view of how an organization transforms inputs into outputs, rather than just examining accounting costs and departmental budgets. It emphasizes the value-adding activities and their interdependencies.
What steps are involved in creating one's own value chain?
-Creating one's own value chain involves mapping out sub-activities for both primary and support activities, analyzing each activity to determine if it adds more value than it costs, and examining the linkages between activities to understand how changes in one can impact others.
How can the value chain be used beyond understanding an organization's value creation?
-Beyond understanding value creation, the value chain can be used to create a target operating model, ensure complete coverage in major change initiatives, and as a tool for understanding acquisition fit by comparing the value chains of the acquiring and target organizations.
What are some potential advantages and disadvantages of using Porter's Value Chain?
-Advantages include increasing margin by clarifying cost and differentiation advantages, creating a shared understanding of value creation, and various strategic uses. Disadvantages include the need for ongoing updates, a focus on internal activities without considering external factors, and the risk of losing sight of the broader strategic picture due to a focus on detailed activities.
Can you provide an example of how Amazon might have used the value chain to identify opportunities for new services?
-Amazon's creation of AWS (Amazon Web Services) can be seen as an example of leveraging its core competency in web hosting at scale for its own operations and then offering this as a service to others. This could have been identified through mapping and analyzing the linkages within their value chain.
Outlines
🍳 Understanding Porter's Value Chain
The paragraph introduces Porter's Value Chain as a strategic tool for mapping internal business activities that add value to customers. It uses the analogy of a chef cooking a meal to explain how value is created beyond the cost of raw materials. The chef's act of cooking transforms ingredients into a more valuable product, which can be sold at a higher price. This concept is extended to businesses, where the value chain helps to identify activities that create margin or value for customers. The purpose of the value chain is to understand and invest in these value-creating activities while eliminating those that do not add value. The value chain was developed by Michael Porter and is detailed in his book 'Competitive Advantage'.
🔍 Deep Dive into Primary and Support Activities
This paragraph delves into the specifics of primary and support activities within the value chain. Primary activities are those that directly contribute to the creation of a product or service, including inbound logistics, operations, outbound logistics, marketing and sales, and service. Support activities, on the other hand, facilitate the smooth operation of primary activities and can influence multiple primary activities simultaneously. Examples of support activities include procurement, human resource management, technology development, and firm infrastructure. The paragraph emphasizes the importance of both primary and support activities in creating a competitive advantage, with primary activities often linked to cost advantages and support activities to differentiation advantages.
🛠️ Crafting and Utilizing Your Own Value Chain
The paragraph outlines the process of creating a personalized value chain for an organization. It suggests starting by mapping out all sub-activities that create value, both primary and support. Each organization's value chain will be unique, reflecting its specific processes and activities. Once mapped, the next step is to analyze each activity to determine if it provides more value than it costs. Activities that do not add value should be reconsidered or discontinued. The final step is to examine the linkages between activities, as changes in one can impact others. The value chain is a dynamic tool that can be used for strategic planning, ensuring comprehensive coverage in change initiatives, and evaluating acquisition fit.
🌟 Applications and Considerations of the Value Chain
This final paragraph discusses the various applications of the value chain, such as creating a target operating model, ensuring complete coverage in change initiatives, and assessing acquisition fit. It also provides an example with Amazon, illustrating how understanding the value chain can lead to new business opportunities, like the creation of Amazon Web Services (AWS). The paragraph concludes with a discussion of the advantages and disadvantages of using the value chain. While it can help increase margins and create a shared understanding of value creation, it requires ongoing updates and may overlook external factors or the broader strategic picture.
Mindmap
Keywords
💡Porter's Value Chain
💡Value Creation
💡Margin
💡Primary Activities
💡Support Activities
💡Inbound Logistics
💡Operations
💡Outbound Logistics
💡Marketing and Sales
💡Service
💡Procurement
Highlights
Porter's Value Chain is a strategic tool for mapping internal business activities that add value to customers.
The value added by a business is the difference between the sales price and the cost of inputs and overheads.
The purpose of the Value Chain is to understand activities that create value or margin within a business.
Investing in value-creation areas and eliminating non-value-adding activities can improve competitive advantage and margins.
The Value Chain was developed by Michael Porter and described in his book 'Competitive Advantage'.
The Value Chain is divided into primary activities that directly develop inputs into outputs and support activities.
Primary activities include inbound logistics, operations, outbound logistics, marketing and sales, and service.
Support activities help primary activities run smoothly and include procurement, human resource management, technology development, and firm infrastructure.
Mapping and using Porter's Value Chain requires deep thought and is not a quick or easy process.
The Value Chain helps in creating a target operating model for future value addition within an organization.
It ensures complete coverage in major change initiatives by serving as a checklist for all activities and their implications.
The Value Chain is useful for understanding acquisition fit by comparing the value-creating activities of different organizations.
Amazon's example illustrates how the Value Chain can reveal opportunities for new services, such as AWS, based on existing competencies.
The key advantage of the Value Chain is increasing margin by clarifying cost and differentiation advantages.
The Value Chain creates a shared understanding of value creation within an organization.
It requires regular revisiting to keep up with changes within the organization.
The model focuses on internal activities and does not consider external factors like competitors or industry trends.
Focusing on detailed activities can sometimes lead to losing sight of the broader strategic picture.
In summary, Porter's Value Chain is a tool for understanding key activities that create margin or value for customers.
Transcripts
hello and welcome to today's lesson
where we're looking at
porter's value chain so what is porter's
value chain
well in a nutshell it's a strategic tool
that helps you map out the internal
business activities you perform
that add value to your customers
to make more sense of this let's
consider the example of a chef
cooking a meal now when a chef cooks a
meal
they can sell that meal for more than
the cost of the raw
ingredients why well because by cooking
the meal
the chef created something more valuable
than just
the ingredients alone now using business
language we can say that the chef has
added
value and a critical factor in all
restaurants
success is to maximize the price
difference between the sales price of
their output
meaning their food and the cost incurred
in creating that output
i.e the ingredients plus any other
overheads now the example of a chef in a
restaurant may seem
very simple but all businesses no matter
how complex
must behave in a similar way they must
take a bunch of
inputs and produce an output
the gap between the value created and
the cost of creating that
output is known as your margin
and if you understand margin then
another way to define the value chain
is as being the set of all activities an
organization performs
to create margin or create value for its
customers
now the purpose of a value chain is to
help you understand
the activities within your business that
create
value or create margin once you
understand this
you can then invest more in your value
creation areas
and eliminate unnecessary business
activities that aren't adding
any value or any margin and
by doing this you'll improve your
competitive advantage
and increase your margin
now the value chain was developed by
michael porter a harvard
business school professor and he
described the value chain in his book
competitive advantage
and i'll include a link to that book
below this
video so with all that out of the way
let's jump in
and take a look at the value chain so
the value chain
isn't based on examining accounting
costs and departmental budgets
instead it takes a process view of how
an organization
transforms inputs into outputs step by
step
which are then bought by customers at a
margin
and using this approach porter was able
to design
a generic chain of activities or a
generic value chain
that you can see here which is common to
all
businesses and broadly speaking the
diagram is broken down into two
categories so first we have primary
activities that directly develop your
inputs into outputs and note that these
primary activities are drawn in the
order
they happen so for example inbound
logistics
happens before outbound logistics and
secondly we have support
activities and these help your primary
activities
run more smoothly so let's jump in and
take a deeper look at both of these
categories so firstly primary activities
now each of your primary activities will
directly relate to the creation
of your product or service so first we
have inbound logistics
and this is the process of orchestrating
the receipt of inputs
and then storing and distributing them
internally
next we have operations so once inbound
logistics have moved
the goods to the right location
operations turn your inputs
into your outputs next we have outbound
logistics
and these deliver your product to your
customer once
operations have produced it now for
physical products this may mean
that you dispatch the product
immediately or store it for a period of
time
next we have marketing and sales now
just because you have created a product
that doesn't mean that your market knows
about it or even wants to buy it
so marketing and sales are responsible
for ensuring the market knows about your
product
and wants to buy it and there are
numerous sub activities involved
in this step like advertising setting
your prices
channel selection partnerships and
managing your sales
pipeline finally we have service
and these activities are those that
occur after you have made
the sale and their purpose is to
maintain or grow
your product or services value after you
have sold it
so this can include things like customer
service activities to reduce
churn customer training and activities
to grow or maintain engagement with your
product
so now let's take a look at support
activities and as we said support
activities
support your primary activities to run
smoothly
and the dotted lines you can see in the
diagram show that support activities can
help
a specific primary activity and also
play a role across all primary
activities so for example
human resources management supports
marketing and sales
but it could also support logistics
so the first activity is procurement
now this is the process of purchasing
the inputs you need
and it's also known as purchasing and it
involves finding new suppliers
and negotiating the best price next we
have
human resource management this activity
involves hiring training
rewarding employee well-being and
retaining good
employees now in today's knowledge
economy
finding and retaining talented employees
can be a significant
source of competitive advantage which is
why many companies even have their own
talent management departments
the next category is technology
development
and this refers to any technology needed
to support
turning your inputs into outputs
technology development includes software
hardware infrastructure and procedures
used to create
your outputs now one thing to note here
is it also includes your r
d or research and development department
finally we have firm infrastructure
and this is a catch all activity for
functions
that support the entire value chain now
note that this infrastructure
is the only support activity in the
diagram that doesn't have dotted lines
going through it
and that is to indicate that it truly
supports
all primary activities equally
now sub activities here include general
management
finance and your legal team
so let's take a look at how to create
your own
value chain but before we do this one
thing to realize
is that support activities are just as
important as primary activities
they just provide a different type of
advantage
so primary activities are the source of
cost
advantage whereas support activities
such as general management or r d
are the source of differentiation
advantage
now mapping and using porter's value
chain
isn't quick or easy and is going to
require
a lot of deep thought but if you want to
generate your own
you can follow these steps so the first
being to map
out your sub activities so for all
primary and support
activities write down all the processes
or activities
that create value now each organization
is unique
so no two value chains should look the
same
once you've completed this step you'll
have a value chain diagram
showing the essential value creating
parts
of your business now the next step is to
analyze
the sub activities so here you analyze
all the activities you've written in
your diagram and think about whether
each activity carried out
provides more value or creates more
margin
than it costs now if you find areas
where you can't definitely say
yes these activities add more value
than they cost then you should consider
changing
or discontinuing these activities and
by performing this step regularly and
making adjustments to your business
or your organization you will
continually grow
your margin and the value you provide to
your customers
the final step is to examine the
linkages
now the value chain of an organization
isn't
just a collection of independent
activities
it's actually a collection of
interdependent activities
related by links or linkages
and a change within one activity will
impact other activities
so for example let's say you identify a
link between
recruiting and sales so that the
better the sales people you hire are the
more products you sell now that might
seem really obvious but these links can
be important
and because links are so important
coordination and communication between
activities are just as important as the
activities themselves
and this means that optimizing your
links is just as important as optimizing
the activities
themselves that create your margin
now the value chain is a powerful
strategic tool
and you can use it for more than just
creating an understanding of how your
organization generates
value so this includes things like
creating a target
operating model so you can use it to
design
how and where you would like to add
value to your chain
in the future so you might not be there
yet but your target operating model can
act as a blueprint
of where you want to get to where you
want your destination to be
so for example consider a car
manufacturer such as volkswagen
moving towards a fully electric cars
so they probably have some target
operating model of where they want to
get to
and they move step by step towards that
model
now another way to use it is in ensuring
complete coverage in major change
initiatives so
suppose you're planning a large scale
change program of work and in that case
you can use your value chain
as a checklist to ensure that you've
considered the implications for all
activities
and all the links between activities
within your organization
and finally it can be a useful tool in
understanding acquisition fit
so suppose you want to acquire another
another organization in that case
comparing your value chain
against that of the organization you're
acquiring can help you determine if the
investment
is a good investment or not so in the
image here you can see that the two
companies
have different drivers of value
creation highlighted in in yellow here
and
it's basically up to you to decide if
this alignment
makes the target organization a good fit
or a profit so
let's take a look at an example to help
this sink in a bit better so for this
example
we're going to take a look at amazon now
obviously
amazon is a very large and complex
company
so we're only going to just scratch the
surface at a very
basic level and map out some of its most
important
sub-activities and in this example
the value-adding activities amazon
performs are written in
orange text and additionally you can see
that we've
linked two activities together web
hosting
and aws now if you don't already know
aws stands for amazon web services
and it's a fully featured cloud platform
provided by 200
data centers globally and it allows
organizations to
amongst other things host and serve
their website
at scale only paying for what they use
now what's interesting here is that
before creating
aws amazon had already been hosting
its own website at scale for many years
the creation of aws took this core
competency and
offered it as a service in its own right
now mapping your value chain allows you
to see
linkages that already exist but it also
also allows you to think of new linkages
so maybe you would think of creating aws
if you hadn't already got it now it's
obviously impossible to say if amazon
used a value chain to spot this
opportunity
but hopefully from this example you can
see the power of understanding your key
value creating activities and the links
between them
so there are several advantages and
disadvantages associated with
the value chain in terms of advantages
then the really the key advantage of
porter's value chain is that it allows
you to increase your margin
and it does this by clarifying how you
create cost advantage
and separately differentiation advantage
now
from this once you know this you can
either cut costs
or increase investment to boost your
margin
secondly it allows you to create a
shared understanding of how value
is created within an organization and
finally there's many different ways
in which you can use the value chain in
terms of
disadvantages then once you've created
your value chain you need to keep
revisiting it to keep it up to date with
changes within your organization
secondly the model is focused on your
internal environment and doesn't
consider external factors such as
competitors
industry trends consumer trends things
like that
finally by focusing on the detail of
activities
and how those activities interact you
can lose
sight of the broader or larger strategic
picture
so in summary porter's value chain is a
tool
enabling organizations to understand the
key activities they perform
that create margin or create value for
their customers
now understanding how you create your
margin
is the first step towards boosting
your margin so that's it for this lesson
i really hope you enjoyed it and i look
forward to speaking to you again soon
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