The business management concept of the value chain was introduced and described by Michael Porter in his popular book "Competitive Advantage: Creating and Sustaining Superior Performance" in 1985. A value chain is a series of activities or processes that aims at creating and adding value to an article (product) at every step during the production process.
Businesses aim at enhancing their margins and thus work to change input into an output which is of a greater value (the difference between the two being the company’s profit margin). The logic behind it is simple: The more value a company creates, the more profitable it is. The enhanced value is passed on to the customers and thus further helps in consolidating a company's competitive edge.
Value-chain business activities are divided into primary activities and secondary activities. The primary activities are directly related to the creation of a good or service, while the support activities help in enhancing the efficiency and work to obtain a competitive advantage among peers. (For related reading, see Industry Handbook: Porter's 5 Forces Analysis)
Let’s take the example of Starbucks (NASDAQ: SBUX) to understand this better. The Starbucks journey began with a single store in Seattle in the year 1971 to become one of the most recognized brands in the world. Starbucks mission is, per its website, “to inspire and nurture the human spirit – one person, one cup and one neighborhood at a time.”
The inbound logistics for Starbucks refer to company-appointed coffee buyers selecting the finest quality coffee beans from producers in Latin America, Africa and Asia. In the case of Starbucks, the green or unroasted beans are procured directly from the farms by the Starbucks buyers. These are transported to the storage sites, after which the beans are roasted and packaged. They are then sent to distribution centers, a few of which are company owned and some of which are operated by other logistic companies. The company does not outsource its procurement, ensuring high quality standards right from the point of selection of coffee beans.
Starbucks operates in 65 countries, either in the form of direct company-owned stores or licensees. Starbucks has more than 21,000 stores internationally, including Starbucks Coffee, Teavana, Seattle’s Best Coffee and Evolution Fresh retail locations. According to its annual report, the company generated 79% of its total net revenue during fiscal year 2017 from its company operated stores while the licensed stores accounted for 10.5%.
There is very little or no presence of intermediaries in product selling. The majority of the products are sold in their own or in licensed stores only. As a new venture, the company has launched a range of single-origin coffees, which will be sold through some leading retailers in the U.S.; these are Guatemala Laguna de Ayarza, Rwanda Rift Valley and Timor Mount Ramelau.
Starbucks invests more in superior quality products and high level of customer service than in aggressive marketing. However, need-based marketing activities are carried out by the company during new products launches in the form of sampling in areas around the stores.
Starbucks aims at building customer loyalty through its stores' customer service. The retail objective of Starbucks is, as it says in its annual report, “to be the leading retailer and brand of coffee in each of our target markets by selling the finest quality coffee and related products, and by providing each customer a unique Starbucks Experience.”
This includes departments like management, finance, legal, etc., which are required to keep the company’s stores operational. Starbucks' well-designed and pleasing stores are complemented with good customer service provided by the dedicated team of employees in green aprons.
Human Resource Management
The committed workforce is considered a key attribute in the company’s success and growth over the years. Starbucks employees are motivated through generous benefits and incentives. The company is known for taking care of its workforce, a key reason for a low turnover of employees, which indicates great human resource management. There are many training programs conducted for employees in a setting of a work culture which keeps its staff motivated and efficient.
Starbucks is very well-known for use of technology, not only for coffee related processes (to ensure consistency in taste and quality along with cost savings) but to connect to its customers. Many customers use Starbucks stores as makeshift office or meeting place because of the free and unlimited WiFi. Back in 2008, the company also launched mystarbucksidea.force.com as a platform where customers can ask questions, give suggestions and openly express opinions and share experiences. The company has implemented some of the suggestions given via this forum. Starbucks also uses Apple’s iBeacon system wherein customers can order their drink through the Starbucks phone app and get a notification of its readiness when they walk in the store.
The Bottom Line
The concept of value chain helps to understand and segregate the useful (which help in gaining a completive edge) and wasteful activities (which hamper market lead) accompanying each step during the product development process. It also explains that if value is added during each step, the overall value of the product gets enhanced thus helping in achieving greater profit margins.
A value chain is used to systematically visualize processes and value adding activities within a business
The value chain is a classic framework to structure the activities of a business. Each step adds value to a product by transforming resources. This value add justifies a profit margin at the end, meaning the price of the end product is higher than the sum of total costs incurred along the value chain.
Michael Porter’s value chain is the most common version
The primary activities in Porter’s value chain are the major contributors to value creation. Supporting activities are necessary to run the business, but not necessarily create value by themselves. These activities are often referred to as overhead.
The above example is mainly applicable for a classic manufacturing process but can also hold well for more abstract service companies, where information is processed. In general, a value chain could also depict an entire industry covering the activities done by several companies in order to produce a complete product. Depending on the industry, primary and supporting activities will vary and will have to be adapted according to industry.
You can use the value chain analysis both in market analysis and company analysis cases
On a company level, the value chain analysis is a powerful tool when you need to determine a root cause of a general problem in a structured way. It can be considered as search pattern within a company’s or an entire industry’s processes. Possible business situations where a value chain analysis may be useful are:
- When there are general quality problems or increasing costs. Here you would lay down the primary and supporting activities. Examine each step to find the exact root cause of the problem.
- If you need to assess a business model, conduct a value chain analysis to figure out the key processes of a company, resulting in most value and margin. Here, you would define the activities that are the core competencies and secondary activities of the client and evaluate strengths and weaknesses (see SWOT analysis) to make more detailed recommendations.
- When facing logistic issues, use it to analyze all parts within a supply chain.
- In case of a business model redesign, conduct a value chain analysis to figure out what steps can be outsourced.
On a market level, the value chain allows you to get a quick overview over relevant players and the power of each participant. If you want to understand a product with respect to its manufacturing and its unique characteristics, follow its production along the value chain. In addition, if you are asked to conduct a profit pool analysis of an industry, you would need to structure it according to value chain steps. Doing so provides transparency about the attractiveness of single steps within a value chain.
- The value chain is a powerful tool to structure your analysis (since it is MECE per definition).
- It usually differentiates between value adding primary activities and supporting activities (a.k.a overhead).
- It is a systematic search patternto analyze both companies and industries.