See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/280246631

value chain

Chapter · January 2014

CITATIONS READS

0 37,266

1 author:

John McGee
The University of Warwick
137 PUBLICATIONS   1,657 CITATIONS   

SEE PROFILE

Some of the authors of this publication are also working on these related projects:

Wiley Encyclopedia of Management - Vol 12 Strategic Management View project

individual research View project

All content following this page was uploaded by John McGee on 22 July 2015.

The user has requested enhancement of the downloaded file.

value chain chosen strategy of the firm. These categories
can be described as follows:
John McGee
• Inbound logistics. Activities associated with
The activities that a firm performs become part receiving, storing, and disseminating rights
of the value added produced from a raw material to the product, such as material handling,
to its ultimate consumption. Figure 1 shows warehousing, stock management, and so on.
how the supply chain forms the basic spine • Operations. All of the activities required
of the Five Forces analysis. It contains all the to transform inputs into outputs and the
activities required to bring the final product critical functions which add value, such as
or service to the final customer. Along the way machining, packaging, assembly, service,
many different firms or businesses have their testing, and so on.
own activities along the supply chain. Thus, • Outbound logistics. All of the activities
each firm has its own value chain, a subset of the required to collect, store, and physically
supply chain. Figure 1 is Porter’s classic picture distribute the output. This activity can
of the value chain. It has two parts. The lower prove to be extremely important both in
part contains those activities (labeled primary generating value and in improving differ-
activities) that are organized in sequence just entiation, as in many industries control
like a production line. Thus, inbound logistics over distribution strategies is proving to
is the first step, leading to manufacturing oper- be a major source of competitive advan-
ations, then outbound logistics, marketing and tage – especially as it is realized that up to
sales, and eventually service. This is a caricature 50% of the value created in many industry
of each firm’s value chain and will contain chains occurs close to the ultimate buyer.
different headings according to the nature of the • Marketing and sales. Activities associated
operations. with informing potential buyers about the
Value is the amount that buyers are willing firm’s products and services, and inducing
to pay for the product or service that a firm them to do so by personal selling, advertising
provides. Profits alter when the value created by and promotion, and so on.
the firm exceeds the cost of providing it. This is • Service. The means of enhancing the phys-
the goal of strategy, and therefore value creation ical product features through after-sales
becomes a critical ingredient in competitive service, installation, repair, and so on.
analysis. Every value activity employs costs such
as raw materials, and other purchased goods
and services for “purchased inputs,” human The second part of the value chain is the upper
resources (direct and indirect labor), and tech- section which contains all the overhead service
nology to transform raw materials into finished elements (labeled support activities) required
goods. Each value activity also creates informa- by the firm. In Porter’s picture he named four
tion that is needed to establish what is going on elements, firm infrastructure, human resource
in the business. Similarly, value is created by management, technology development, and
reducing stocks, accounts receivable, and so on, procurement:
while value is lost via raw material purchases and
other liabilities. Most organizations, thus engage 1. Procurement. This concerns the acqui-
in many activities in the process of creating sition of inputs or resources. Although,
value. These activities can generally be classified technically this is the responsibility of the
into either primary or support activities. These purchasing department, almost everyone
are illustrated in Figure 1, which details the in the firm is responsible for purchasing
view of Michael Porter, who states that there something. While the cost of procurement
are five generic categories of primary activities itself is relatively low, the impact can be very
involved in competing in any industry. Each high.
of these is divisible into a number of specific 2. Human resource management. This consists
activities that vary according to the industry and of all activities involved in recruiting, hiring

Wiley Encyclopedia of Management, edited by Professor Sir Cary L Cooper.

Copyright © 2014 John Wiley & Sons, Ltd.
2 value chain

Firm infrastructure

Human resource management

Support
activities Technology development

Procurement

Service
Inbound Operations Outbound Marketing
logistics logistics & sales

Primary activities

Figure 1 The generic value chain. Source: Porter (1985).

and training, developing, rewarding, and • Indirect. These are activities that facilitate
sanctioning the people in the organization. the performance of the direct activities on
3. Technology development. This is concerned a continuing basis, such as maintenance,
with the equipment, hardware, software, scheduling, and administration.
technical skills, and so on, used by the firm • Quality assurance. These are activities that
in transforming inputs to outputs. Some insure the quality of other activities, such
such skills can be classified as scientific, as monitoring, inspecting, testing, and
while others – such as food preparation checking.
in a restaurant – are “artistic.” Such skills
are not always recognized. They may also The value chain is another generic frame-
support limited activities of the business, work that permits a range of applications and
such as accounting, order procurement, and analyses. It permits the analyst to divide the
so on, and in this sense may be likened to the firm’s activities into broad categories (as above)
value added component of the experience and increasingly into more specific categories.
effect. Thus, operations might be refined into sub-
4. Firm infrastructure. This consists of the components and assembly: marketing and sales
many activities, including general manage- into market research, product development,
ment, planning, finance, legal, external sales force, and so on. The usefulness of this
affairs, and so on, which support the oper- is to be able to identify those activities that are
ational aspect of the value chain. This may the source of the competitive advantage and to
be self-contained in the case of an undiver- be able to locate them within the value chain.
sified firm or divided between the parent For example, if Intel’s competitive advantage is
and the firm’s constituent business units. product performance and this is derived (at least
in large part) from R&D activities, then this can
Within each category of primary and support be isolated within the value chain and measured,
activities, Porter identifies three types of activity, compared to competitors, and provided with
which play different roles in achieving competi- support.
tive advantage: Competitive advantage is often quite subtle in
its manifestation and in its sources. Cost advan-
• Direct. These are activities directly involved tage might arise from the way in which every
in creating value for buyers, such as assembly, single activity in the value chain is linked to the
sales, and advertising. others and managed for efficiency. The story of
 value chain 3
the low-cost airlines such as EasyJet, Ryanair, the correct units of analysis, an issue which the
and Southwest Airlines is about system manage- value chain solved brilliantly.
ment of the costs as well as focus on driving Therefore a normal cost analysis procedure
down each cost component. Differentiation can take place with the following stages.1
may be delivered as a service quality perception
driven by the way in which each element of 1. Define the value chain in terms of those
service delivery is managed systematically along elements that relate to the sources of
with all other elements in order to differentiate competitive advantage. Key considerations
the product. are
The value chain can be a powerful tool in – the separateness and independence of
diagnosing and explaining how the management one activity from another;
of competitive advantage takes place within – the importance of an activity in relation
to competitive advantage and to the
the firm. The interrelationships between the
margin;
elements of the value chain provide an impor-
– the dissimilarity of activities in terms of
tant explanation of the nature of competitive
requiring different cost drivers;
advantage in large, complex organizations. Such
– the extent to which there are differences
organizations typically are rich in tacit knowl- in the way competitors perform activ-
edge. This is the kind of knowledge that you ities (i.e., where there are differences
call upon to ride a bicycle. We all know how there are potential advantages to be
to do this – but it is impossible to explain gained).
it. Similarly, large corporations are used to 2. Establish the relative importance of
making links between complex and far-flung different activities in the total cost of the
activities, and between related and unrelated product. This means assigning costs to each
technologies. This “glue,” binds these compa- activity based on management accounts
nies together and makes it impossible for others or other customized analysis procedures.
to imitate quickly. The “hidden” part of the The distinctions made earlier about fixed
value chain is these linkages that contain the and variable costs, sunk costs, and cost
tacit knowledge. The way this “glue,” works allocations are really significant issues at
determines the level of vertical integration, this stage. Errors in cost analysis can lead
that is, those elements of the supply chain that to significant misunderstanding of what
can be brought within the value chain and contributes to profits and how valuable is a
within the firm and those that should remain competitive advantage.
outside the firm. The guiding principle is that 3. Compare costs by activity and bench-
when the costs of internal transactions (making mark against competitors. The comparison
the glue work properly) exceed the costs of is not in terms of how big are the costs
buying outside, then the firm should source but how different are they from efficiency
outside its boundaries. benchmarks and from competitor standards.
4. Identify cost drivers. These are the forces
THE VALUE CHAIN AND COST ANALYSIS that move costs up or down. Planned scale of
activities is a driver of overall plant cost and
The value chain provides a good basis on which so also is degree of capacity utilization. A
to conduct a cost analysis. Its principal advan- driver of sales force costs might be product
tage is that the elements of the value chain are range – if the range is too small costs will be
already organized around those issues that are high. Another driver will be geographical
important in driving competitive advantage and concentration of customers and another
profitability. Porter (1985) was, therefore, able might be sales communication methods
in his book to make very strong links with the (face to face or remote teleconferencing).
array of literature and practice on cost cutting For labor intensive activities critical drivers
that was already available. A criticism of the cost might be wage rates, speed of production
analysis literature was the difficulty of defining line, and defect rates. It is through the
4 value chain
understanding of cost drivers that signifies value chains of different competitors often iden-
how well you understand the nature of your tifies ways of achieving strategic advantage by
business. One needs to look behind the reconfiguring the value chain of the individual
obvious to identify the fundamentals. firm. In assigning costs and assets it is important
5. Identify linkages between activities. Inter- that the analysis be done strategically rather
relationships may be very many in number than seeking accounting precision. This should
– the critical cost drivers may seemingly be accomplished using the following principles:
relate to another activity entirely. A compar-
ison can be made between Xerox and • operating costs should be assigned to activi-
Canon in the photocopying industry. Xerox ties where incurred;
found that its service costs were driven • assets should be assigned to activities where
by design complexity and manufacturing employed, controlled, or influencing usage;
inefficiencies. Grant observes that: • accounting systems should be adjusted to fit
value analysis;
… the optimisation of activities through • asset valuation may be difficult but should
the value chain has become a major source recognize industry norms – particular care
of cost reduction, and speed enhancement should be taken in evaluating property
has become a key challenge for computer assets.
integrated manufacturing.
(Grant, 2002, p. 271) The reconfiguration of the value chain has
often been used by successful competitors in
6. Identify opportunities for reducing costs. achieving competitive advantage. When seeking
By identifying areas of obvious inefficiency to reconfigure the value chain in an industry, the
(i.e., deviations from designed machine following questions need to be asked:
performance standards) and of deficiencies
against competitive benchmarks, opportu- • how can an activity be done differently or
nities for cost reduction become evident. even eliminated?
Very often the option is posed of contracting • how can linked value activities be reordered
outside the firm for components or services. or regrouped?
Some firms have subcontracted entire IT • how could coalitions with other firms reduce
or eliminate costs?
departments. Currently, European firms are
outsourcing their call centers to India. The Successful reconfiguration strategies usually
automobile companies are going through an occur with one or more of the following moves: a
extensive process of outsourcing. The Ford new production process, automation differences,
Fiesta plants in Cologne outsource fully direct versus indirect sales strategy, the opening
made-up doors (as a subsystem) to plants of new distribution channels, new raw materials
adjacent to the Ford plant. used, differences in forward and/or backward
integration, a relative location shift, and new
IDENTIFYING THE VALUE CHAIN advertising media. A good example of this is
the emergence of German volume discoun-
The value chain concept thus helps to iden- ters (Lidl and Aldi) on the UK food retailing
tify cost behavior in detail. From this analysis, scene. According to The Economist (2008) these
different strategic courses of action should be “hard” discounters “stock a fraction of the goods
identifiable to develop differentiation and less that a normal supermarket offers, resulting in
price sensitive strategies. Competitive advantage fewer suppliers, a high volume of purchases
is then achieved by performing strategic activi- and sales, and massive economies of scale.” The
ties better or cheaper than competitors. German discount model is based on a different
To diagnose competitive advantage, it is neces- combination of competitive positioning and
sary to define the firm’s value chain for operating value chain configuration resulting in a new
in a particular industry and compare this with and possibly better business model according to
those of key competitors. A comparison of the some observers.2
 value chain 5
ENDNOTES McGee, J., Wilson, D. and Thomas, H. (2010) Strategy:
Analysis and Practice, 2nd edn, McGraw-Hill, Maid-
1 This section draws on Grant (2002, Chapter 7). enhead.
2 Forinstance, Philippe Suchet of Exane BNP Porter, M.E. (1985) Competitive Advantage; Creating and
Paribas in Paris quoted in The Economist Sustaining Superior Performance, The Free Press, New
York.
(2008).
The Economist (2008) The Germans are coming, 16
August.
Bibliography

Grant, R.M. (2002) Contemporary Strategy Analysis:

Concepts, Techniques and Applications, 4th edn, Black-
well Business, Oxford.

View publication stats