Strategy & competition
Value Chain Analysis
A disaggregation of the firm into nine strategically relevant activities, five primary and four support, to locate where cost is incurred and differentiation is created, on the premise that advantage lives in activities, not in the firm as a whole.
Also known as Porter's value chain, Value chain model. First set out by Michael E. Porter in 1985; the primary source is cited in full below.
- Format
- Structural model
- Level
- Business unit · Product
- Best for
- Position against competitors · Allocate resources · Analyse the environment
- Decision stage
- Diagnose · Explore options · Plan
- Difficulty
- Advanced
- Time to apply
- Several days to weeks for a proper pass with cost allocation; a structured workshop can produce a useful qualitative first cut in a day.
Plate · The model
The components
Firm infrastructure
The activities that support the entire chain rather than any single activity: general management, planning, finance, accounting, legal, quality management and, in a multi-site business, whatever the centre does. Frequently viewed as pure overhead; occasionally a genuine source of advantage.
Signals of strength
Cost of the centre as a share of revenue, benchmarked · Duplication of management functions across sites or units · Planning and finance capability that enables faster, better decisions · Governance overhead that slows the primary activities
Human resource management
Recruiting, hiring, training, development and compensation across the whole chain. Its effects surface inside other activities: service quality, operations skill, sales effectiveness, and it shapes cost through wages and turnover.
Signals of strength
Turnover and its cost concentrated in particular activities · Training investment aligned with the activities that differentiate · Pay structures competitive for the skills that matter most · Hiring lead times constraining growth or service
Technology development
Every activity embodies technology, so this category covers efforts to improve product and process across the chain: R&D, process automation, systems and data. It ranges from genuine research to the EPOS system and the website.
Signals of strength
Technology spend mapped to the activities it improves · Process technology gaps versus best-practice competitors · Data captured in one activity being used to improve others · Legacy systems taxing multiple activities at once
Procurement
The function of purchasing inputs used anywhere in the chain, distinct from the purchased inputs themselves: goods for resale, materials, equipment, energy and services. Small improvements here fall straight through to margin, and the function is chronically under-managed relative to its leverage.
Signals of strength
Spread of buying power across many uncoordinated buyers · Supplier terms benchmarked against peers of similar scale · Purchased-input quality driving cost or returns downstream · Single-source dependencies with no negotiating position
Inbound logistics
Receiving, storing and disseminating inputs to the product: materials handling, warehousing, inventory control, vehicle scheduling and returns to suppliers.
Signals of strength
Inventory holding costs and write-offs from over-ordering · Goods-received quality checks catching problems early or late · Stock accuracy sufficient to promise availability · Handling steps that add cost without adding value
Operations
Transforming inputs into the final product or service: machining, assembly, packaging, testing, facility operations. In a service or retail business, this is the activity the customer experiences directly.
Signals of strength
Capacity utilisation across sites, seasons or shifts · Waste, shrinkage and rework rates · Consistency of output quality across locations · Unit economics compared at activity level with rivals
Outbound logistics
Collecting, storing and distributing the product to buyers: finished-goods warehousing, order processing, delivery scheduling and, increasingly, fulfilment of online orders.
Signals of strength
Cost per order or per delivery against benchmark · Order accuracy and damage rates · Delivery promise versus what competitors offer · Fulfilment capacity constraining the growth channel
Marketing and sales
The activities by which buyers learn of, choose and can purchase the product: advertising, promotion, sales force, channel selection and pricing.
Signals of strength
Customer acquisition cost by channel · Pricing discipline versus discount drift · Marketing spend aligned to the segments that pay premiums · Conversion evidence rather than footfall or traffic alone
Service
Activities that enhance or maintain the product's value after the sale: installation, repair, training, parts, advice and complaint handling. Often the least measured activity and, in mature markets, frequently the most differentiating one.
Signals of strength
Repeat-purchase and retention rates attributable to service · Cost and speed of complaint resolution · After-sales revenue captured or ceded to third parties · Service knowledge feeding back into product and operations
When it earns its keep
- You need to know where your margin actually comes from, activity by activity, rather than at the level of the P&L's summary lines.
- You are pursuing cost leadership and need to find which activities drive cost and which could be done differently, cheaper or not at all.
- You are pursuing differentiation and need to trace which activities create the value buyers actually pay a premium for, so investment lands where it matters.
- You are weighing outsourcing, vertical integration or shared services and need to see which activities are strategic and which are merely necessary.
And when it doesn't
- The question is about industry attractiveness or external forces. The value chain analyses the firm's own activities; use Five Forces for the structure around it.
- The business creates value through networks or intermediation, as platforms and marketplaces do. The linear chain fits transformation businesses; value networks and value shops need different configurations.
- You need a quick answer. Done honestly, the analysis requires allocating costs and assets to activities, and half-done cost allocation produces confident nonsense.
- The unit of analysis is a diversified group. The value chain is drawn at business-unit level; a corporate-level chain averages away everything of interest.
How to run it
Before starting, gather the inputs the analysis depends on:
- A defined business unit and a map of what it actually does, end to end, from inbound goods to after-sales service.
- Cost and asset data that can be reallocated from accounting categories to activities, however roughly at first.
- Evidence on what buyers value and pay a premium for, since half the analysis is about differentiation rather than cost.
- Comparative intelligence on how competitors configure the same activities, because advantage is only visible relative to them.
- A view of linkages up and down stream, to supplier and channel value chains, where much optimisation actually lies.
- 1
Define the business unit and draw its chain
Identify the strategically distinct business and disaggregate it into the nine generic categories, then subdivide each into the discrete activities that matter here. The generic labels are scaffolding; the analysis happens at the level of activities specific to this business.
- 2
Allocate costs and assets to activities
Reassign operating costs and assets from accounting lines to activities. Precision matters less than coverage: the point is to discover which activities absorb disproportionate cost or capital, which the P&L format is designed to conceal.
- 3
Identify the drivers of cost and uniqueness
For each significant activity, ask what drives its cost (scale, capacity utilisation, learning, location, timing) and what makes it a source of buyer value. The same activity is often both a cost centre and the reason customers stay.
- 4
Trace the linkages
Look for connections where the way one activity is performed affects the cost or effectiveness of another, including across the boundary into supplier and channel chains. Porter's argument is that linkages are harder for rivals to see and copy than individual activities, and are therefore the more durable advantage.
- 5
Compare against competitors
Establish, as far as evidence allows, how rivals configure the same activities and at what cost. Advantage is relative: an efficient activity is not a strength if every competitor performs it the same way.
- 6
Choose where to act
Decide which activities to invest in, which to re-engineer, which to outsource and which to stop. The analysis is complete when it produces a different allocation of money and attention across activities than the one the firm started with.
Reading the result
An activity map of the business with costs and assets allocated to it, the drivers of cost and differentiation identified per activity, the linkages between activities made explicit, and a judgement of which activities to invest in, re-engineer, outsource or stop.
- Read cost and value together. The dangerous conclusions come from reading cost alone: the most expensive activity is often the one buyers are paying the premium for.
- Look hardest at the linkages. Individual activities can be benchmarked and copied; the way a firm's activities fit together is where sustained advantage, and Porter's later notion of strategic fit, actually lives.
- Support activities are read across the whole chain. Procurement or technology weakness taxes every primary activity at once, which is why modest improvements there compound.
A worked example
A family-owned garden centre group hunts for margin in its value chain
A six-site garden centre group in the South West is profitable but drifting: supermarkets and DIY sheds undercut it on commodity plants and compost, while online retailers take the equipment sales. Rather than discount across the board, the managing director runs a value chain analysis to find out where the group actually makes its money and where it leaks.
- Firm infrastructure
- Each site keeps its own books and rotas, and the centre is essentially a payroll function. The duplication costs roughly a site manager's salary per year in administrative time, and no one produces group-level margin data by category, which is why this analysis is being done from scratch.
- Human resource management
- The group's horticultural expertise sits in a dozen long-serving plant-area staff, with no succession plan and seasonal hiring done site by site at varying quality. The expertise is the differentiator customers cite, and it is one retirement wave from disappearing.
- Technology development
- EPOS systems differ across sites, so stock cannot be viewed group-wide, and the website shows no live availability. Customers ring round sites to find a plant. A single stock system is unglamorous and would improve procurement, logistics and marketing simultaneously, a textbook linkage.
- Procurement
- Six sites buy from overlapping nursery and sundries suppliers on separately negotiated terms. Consolidating the top twenty suppliers group-wide is conservatively worth two to three points of gross margin on bought-in goods, the largest single number the analysis surfaces.
- Inbound logistics
- Plant deliveries arrive site by site with no quality gate; write-offs of stressed stock run near four per cent of plant cost. A shared quality standard at goods-in, plus consolidated deliveries to the two largest sites for onward transfer, would cut both waste and delivery charges.
- Operations
- The plant areas and expert staff are the operation customers travel for, and they are subsidising a sprawling non-core retail range of giftware and clothing that turns slowly and ties up floor space. Category-level margin data, once assembled, shows a third of floor space produces under a tenth of contribution.
- Outbound logistics
- Home delivery of bulky goods is improvised per site with a van and goodwill, unpriced against cost. It loses money on every compost run but is also cited by loyal customers as a reason they buy bulky goods here rather than online. It needs pricing and scheduling, not abolition.
- Marketing and sales
- Marketing spend goes on local print advertising, while the loyalty scheme's data sits unused. The customers who buy plants, the high-margin differentiated category, are identifiable and contactable, and nobody has ever segmented them.
- Service
- Free planting advice, plant guarantees and the tea rooms drive the dwell time and repeat visits the business model depends on. None of it is measured or costed, yet it is plainly part of why customers accept premium plant prices. Guarantee-claims data, if collected, would also feed back into supplier quality at goods-in.
The read. The analysis relocates the strategy. The group's advantage lives in plant expertise and after-sale service, and its margin leaks live in the support activities: fragmented procurement, duplicated administration and incompatible systems. The plan writes itself in sequence: consolidate buying terms first because the gain is largest and fastest, then a single EPOS and stock platform to unlock the linkages, then rationalise non-core retail space in favour of the differentiating plant offer. Competing with supermarkets on commodity compost is explicitly abandoned. The one warning the chain surfaces is to protect the loss-making delivery service and the unmeasured advice culture, because reading cost without value would have cut the two things customers actually come for.
Pitfalls
- Mistaking the P&L for the analysis. Accounting categories cut across activities, and until costs are reallocated to activities the chain is a diagram, not a diagnosis.
- Reading cost without value. Activity-based cost-cutting that ignores which activities create buyer value is how firms efficiently destroy their own differentiation.
- Stopping at the generic nine labels. Porter is explicit that the categories must be subdivided into the discrete activities relevant to the particular business; an analysis conducted at the level of 'operations' has not started.
- Analysing the firm's chain in isolation. The firm sits in a value system of supplier, channel and buyer chains, and linkages across those boundaries are often worth more than internal ones.
- Treating support activities as overhead to be minimised. Procurement, technology and HR act on every primary activity at once, and underinvestment there taxes the whole chain invisibly.
What the critics say
The chain metaphor assumes a linear transformation business. Stabell and Fjeldstad showed that firms creating value by solving problems (value shops) or by mediating between customers (value networks) fit the model poorly, and that forcing banks, hospitals or platforms into the nine categories obscures how they actually create value.
Stabell, C. B. and Fjeldstad, Ø. D. (1998) 'Configuring value for competitive advantage: on chains, shops, and networks', Strategic Management Journal, 19(5), pp. 413–437.
Normann and Ramírez argued that value is co-produced in constellations of actors rather than added sequentially along a chain, and that the framework's sequential logic misleads strategists in economies where offerings are configured with customers and partners rather than delivered to them.
Normann, R. and Ramírez, R. (1993) 'From Value Chain to Value Constellation: Designing Interactive Strategy', Harvard Business Review, 71(4), July–August, pp. 65–77.
The analysis is data-hungry and static. Allocating costs and assets to activities defeats many management-accounting systems in practice, and the resulting snapshot ages as technology and outsourcing options shift, so the rigorous version is done rarely and the casual version is done badly.
Sources and further reading
- Porter, M. E. (1985) Competitive Advantage: Creating and Sustaining Superior Performance. New York: Free Press. ↗
- Porter, M. E. (1996) 'What Is Strategy?', Harvard Business Review, 74(6), November–December, pp. 61–78. ↗
- Stabell, C. B. and Fjeldstad, Ø. D. (1998) 'Configuring value for competitive advantage: on chains, shops, and networks', Strategic Management Journal, 19(5), pp. 413–437.
- Institute for Manufacturing, University of Cambridge: Porter's Value Chain. ↗