Value Chain Guide: How Does a Value Chain Work?

A value chain refers to the entirety of logistical efforts and processes that a business engages in to produce a completed product or service. A value chain begins with the initial collection of materials used to create the end-product product and ends with delivery and services for the consumer. Businesses can perform a value chain analysis to examine the efficiency and cost-effectiveness of how their systems support one another to create products quickly and economically and maximize profit.

Economic theorist and Harvard Business school professor Michael Porter created a method of evaluating the value chain in his 1985 book Competitive Advantage: Creating and Sustaining Superior Performance. Porter's value chain can be divided into five primary activities (including inbound logistics, operations, outbound logistics, marketing and sales, and service) and four secondary activities that support those primary activities (procurement, human resource management, technological development, and infrastructure).

The value chain concept works by breaking down the process of creating and delivering a product or service in order to assess the efficiency of the whole process better. The value chain model offers businesses a clearer picture of how expenses are broken down over the complete cycle of delivering a product. From there, businesses can alter their business strategy to mitigate production and financial inefficiencies for greater cost advantages and value creation.

Porter’s value chain analysis framework defines the five primary value chain activities as the primary efforts that a business engages in to create and distribute a product or service. Here are the primary activities in the value chain.

1. 1. Inbound logistics: Inbound logistics refers to the acquisition and storage of the businesses’ raw materials and products, as well as all relationships with providers.
2. 2. Operations: A business’ operations comprises all of the processes involved in transforming raw materials into the finished product that the business will distribute, market, and sell to the consumer.
3. 3. Outbound logistics: Outbound logistics entails all shipping and distribution of the final product to consumers, distributors, and retailers once the product or service is complete. It can also refer to warehousing for storage of the final product for eventual sale.
4. 4. Marketing and sales: Marketing and sales are all the activities performed by the company to market the completed product to the consumer, as well as all relationships with advertisers and promoters.
5. 5. Service: This refers to any continuing services to enhance the product experience after the sale, such as maintenance, quality assurance, repair services, refund, or other customer services.

The value chain framework defines the secondary value chain activities as day-to-day support endeavors that a company engages in to produce a product and or service and run the business. Here are the four secondary value chain activities.

1. 1. Procurement: In order for a company to perform inbound logistics, they need to procure the materials to create the product first. Procurement involves sourcing raw materials and negotiating prices with vendors or suppliers to obtain the elements necessary to create a product.
   
2. 2. Human resources management: HR management refers to the hiring and retention of employees that the business needs to deliver on all five of the primary activities, from operations to customer service.
3. 3. Technological development: Technology development refers to a business developing proprietary technologies and product design to make activities such as operations or services more efficient. This can also include a business researching and developing new hardware or software that will become a part of internal operations and outbound operations to make running the business easier.
4. 4. Firm infrastructure: Infrastructure refers to the foundations of the business that enable it to keep functioning. This includes departments such as accounting, general management, legal, and administration.

A business can perform a value chain analysis to assess the efficiency of each stage of its value chain. Breaking down each primary and secondary value chain activity into sub-activities can help a business locate pain points and opportunities to lower costs in the chain. Businesses that regularly assess their value chain activities can better understand the value costs and against competitors. They can also isolate weaknesses that should be addressed to strengthen their competitive advantage and increase profitability.

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