Porter's Value Chain Explained

Summary

Porter'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

00:00

🍳 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'.

05:02

🔍 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.

10:03

🛠️ 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.

15:07

🌟 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.

Keywords

💡Porter's Value Chain

Porter's Value Chain is a strategic tool developed by Michael Porter that helps organizations map out the internal activities that add value to their customers. It is central to the video's theme as it is the main concept being discussed. The video explains that this tool can help businesses understand and maximize the price difference between their output (product or service) and the cost of creating that output, which is the margin. The Value Chain is divided into primary and support activities, and understanding these can lead to improved competitive advantage and increased margins.

💡Value Creation

Value creation refers to the process by which a business transforms inputs into outputs that are more valuable to the customer. In the context of the video, value creation is the core of the Value Chain concept, where activities are performed to add value to the customer, thus creating a margin. The video uses the example of a chef cooking a meal, which, through the process of cooking, becomes more valuable than the sum of its raw ingredients.

💡Margin

Margin is the difference between the sales price of a product or service and the cost incurred in creating that product or service. The video emphasizes that understanding and maximizing margin is key to business success. It is the gap that results from the value created and the cost of creating that value, and optimizing this gap is a primary goal when using Porter's Value Chain.

💡Primary Activities

Primary activities are the activities within the Value Chain that directly contribute to the creation of a product or service. The video outlines these activities as inbound logistics, operations, outbound logistics, marketing and sales, and service. These activities are sequenced in the order they occur and are crucial for transforming inputs into outputs that customers are willing to pay for.

💡Support Activities

Support activities are those that facilitate the smooth operation of primary activities. The video mentions procurement, human resource management, technology development, and firm infrastructure as examples of support activities. These activities do not directly create the product or service but are essential for the efficiency and effectiveness of the primary activities.

💡Inbound Logistics

Inbound logistics is one of the primary activities in the Value Chain and refers to the process of receiving, storing, and distributing inputs within an organization. The video explains that this activity is the first step in the chain, setting the stage for the transformation of inputs into outputs.

💡Operations

Operations is a primary activity within the Value Chain where the actual transformation of inputs into outputs occurs. The video uses the term to describe the core process of creating the product or service that will be sold to the customer, emphasizing its importance in the value creation process.

💡Outbound Logistics

Outbound logistics is another primary activity that involves delivering the finished product to the customer. The video highlights this as a critical step in ensuring that the product reaches the customer after it has been produced, which is essential for realizing the value created.

💡Marketing and Sales

Marketing and sales are primary activities that ensure the market is aware of the product and wants to purchase it. The video explains the importance of these activities in creating demand and facilitating the sale, which is necessary for realizing the value added during the production process.

💡Service

Service is a primary activity that involves activities after the sale to maintain or increase the value of the product or service. The video mentions customer service, customer training, and engagement activities as examples of services that can help reduce churn and maintain customer satisfaction, which are key to long-term value creation.

💡Procurement

Procurement is a support activity that involves the process of purchasing inputs needed for the production of the product or service. The video discusses how effective procurement can lead to cost savings and is an important part of the value chain in terms of cost management.

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