What is a value chain and why is it important? (2024)

What is a value chain?

A value chain is a concept describing the full chain of a business's activities in the creation of a product or service -- from the initial reception of materials all the way through its delivery to market, and everything in between.

The value chain framework is made up of five primary activities -- inbound operations, operations, outbound logistics, marketing and sales, service -- and four secondary activities -- procurement and purchasing, human resource management, technological development and company infrastructure.

A value chain analysis is when a business identifies its primary and secondary activities and subactivities, and evaluates the efficiency of each point. A value chain analysis can reveal linkages, dependencies and other patterns in the value chain.

The value chain concept was first described in 1985 by Harvard Business School professor Michael Porter, in his book Competitive Advantage: Creating and Sustaining Superior Performance.

How do value chains work?

The value chain framework helps organizations identify and group their own business functions into primary and secondary activities.

Analyzing these value chain activities, subactivities and the relationships between them helps organizations understand them as a system of interrelated functions. Then, organizations can individually analyze each to assess whether the output of each activity or subactivity can be improved -- relative to the cost, time and effort they require.

When an organization applies the value chain concept to its own activities, it is called a value chain analysis.

Primary activities

Primary activities contribute to a product or service's physical creation, sale, maintenance and support. These activities include the following:

• Inbound operations. The internal handling and management of resources coming from outside sources -- such as external vendors and other supply chain sources. These outside resources flowing in are called "inputs" and may include raw materials.
• Operations. Activities and processes that transform inputs into "outputs" -- the product or service being sold by the business that flow out to customers. These "outputs" are the core products that can be sold for a higher price than the cost of materials and production to create a profit.
• Outbound logistics. The delivery of outputs to customers. Processes involve systems for storage, collection and distribution to customers. This includes managing a company's internal systems and external systems from customer organizations.
• Marketing and sales. Activities such as advertising and brand-building, which seek to increase visibility, reach a marketing audience and communicate why a consumer should purchase a product or service.
• Service. Activities such as customer service and product support, which reinforce a long-term relationship with the customers who have purchased a product or service.

As management issues and inefficiencies are relatively easy to identify here, well-managed primary activities are often the source of a business's cost advantage. This means the business can produce a product or service at a lower cost than its competitors.

Secondary activities

The following secondary activities support the various primary activities:

• Procurement and purchasing. Finding new external vendors, maintaining vendor relationships, and negotiating prices and other activities related to bringing in the necessary materials and resources used to build a product or service.
• Human resource management. The management of human capital. This includes functions such as hiring, training, building and maintaining an organizational culture; and maintaining positive employee relationships.
• Technology development. Activities such as research and development, IT management and cybersecurity that build and maintain an organization's use of technology.
• Company infrastructure. Necessary company activities such as legal, general management, administrative, accounting, finance, public relations and quality assurance.

Benefits of value chains

The value chain framework helps organizations understand and evaluate sources of positive and negative cost efficiency. Conducting a value chain analysis can help businesses in the following ways:

• Support decisions for various business activities.
• Diagnose points of ineffectiveness for corrective action.
• Understand linkages and dependencies between different activities and areas in the business. For example, issues in human resources management and technology can permeate nearly all business activities.
• Optimize activities to maximize output and minimize organizational expenses.
• Potentially create a cost advantage over competitors.
• Understand core competencies and areas of improvement.

A value chain analysis can offer important benefits; however, when emphasizing granular process details in a value chain, it's important to still give proper attention to an organization's broader strategy.

How to conduct a value chain analysis

A value chain analysis is a process that helps organizations understand points in their value chain, as well as relationships between these different points. Conducting a value chain analysis helps a company identify factors that create or hinder cost efficiency in its business model.

When undergoing a value chain analysis, businesses should regard the framework as a starting point rather than a complete start-to-finish process.

Here are some steps that companies can take to understand their value chains:

1. Break each primary and secondary activity down into subactivities. Organizations can then analyze each function on a more granular level, to compare the financial return of each function to the time, effort and cost required.
2. Look for connections between subactivities. Often, the inefficiency of one activity or subactivity is linked to another. For example, an ill-advised HR hire can create issues that permeate into many different subactivities. Technology and inbound operations can also have rippling effects throughout a company's value chain.
3. Diagnose areas of improvement. Consider trends and patterns in the different subactivities and connections between subactivities, and evaluate for potential improvement opportunities in those particular points in the value chain.

Examples of value chains

Here are some examples of tech/e-commerce giant Amazon's primary activities.

Inbound logistics. Amazon's primary inputs can be identified as products sold through its own fulfillment services, as well as data center resources that fuel Amazon Web Services (AWS) cloud offerings.

Here, Amazon can use its size as a large operation to lower the costs per unit of items it purchases from external suppliers.

Operations. This is where Amazon transforms its inputs into outputs.

Amazon's core offering, its online marketplace, offers a secure platform that makes e-commerce easy for both customers and sellers. As Amazon's fulfillment and logistics can offer two-day shipping to Prime members, the result is a secure, user-friendly customer experience with dramatically lower shipping times than competitors for a similar price point.

Another Amazon business unit, AWS, transforms inputs into outputs by creating and maintaining cloud servers, storage and other data center resources into a streamlined service for client organizations to host applications and other data.

Outbound logistics. Amazon's outbound logistics includes Amazon fulfillment centers, digital delivery, co-sourcing and outsourcing, and brick-and-mortar stores.

• Amazon's 109 fulfillment centers incorporate the use of robotics for fast, cost-efficient warehouse labor. Amazon's two-day shipping is a major distinguishing point over the competition.
• Co-sourcing and outsourcing agreements allow Amazon to scale beyond the capacity of its in-house fulfillment services.
• Some services may be delivered digitally -- such as the software for Amazon's online marketplace and AWS cloud services.
• Brick-and-mortar stores include Whole Foods and various Amazon retail stores. These physical retail spaces also contribute to other Amazon primary activities, such as service. For example, online returns can be dropped off at certain Whole Foods locations, Kohl's department stores and UPS locations. Furthermore, customer service representatives in these stores are easily accessible for customers who would prefer to receive help in-person.

Marketing and sales. According to Statista.com, Amazon spent approximately $22 billion in marketing and advertising costs in 2020, using the financial power of a company of its size to maintain its role as one of the most recognizable brands today.

Service. In its mission to be the most customer-centric company, Amazon is known for its simple and easy return process, as well as its high customer satisfaction ratings for AWS cloud services.