porters-value-chain-model

What is Porter’s Value Chain Model And Why It Matters In Business

In his 1985 book Competitive Advantage, Porter explains that a value chain is a collection of processes that a company performs to create value for its consumers. As a result, he asserts that value chain analysis is directly linked to competitive advantage. Porter’s Value Chain Model is a strategic management tool developed by Harvard Business School professor Michael Porter. The tool analyses a company’s value chain – defined as the combination of processes that the company uses to make money.

Contents

Understanding Porter’s Value Chain model

Porter’s Value Chain model is a strategic management tool developed by Harvard Business School professor Michael Porter.

The tool analyses a company’s value chain – defined as the combination of processes that the company uses to make money.

In his 1985 book Competitive Advantage, Porter explains that a value chain is a collection of processes that a company performs to create value for its consumers. As a result, he asserts that value chain analysis is directly linked to competitive advantage.

Competitive advantage occurs when a business systematically examines its internal processes and how they interact with each other. Each process in the value chain should create value that exceeds the cost of creating that value. In other words, it should be profitable.

The strength of Porter’s model lies in its focus on customers through value chain systems. This is in contrast to other value chain models that focus on departmental and accounting expenses, for example. 

Value Chain vs. Supply Chain

A value chain comprises the activities a company performs to create value for customers and maximize its competitive advantage.

A supply chain, on the other hand, describes the network of entities that source raw materials, transform them into products, and distribute or sell them to customers.

Understanding value chains

Value chains encompass the input activities a company performs to create value for customers.

Essentially, these companies take inputs and transform them into outputs that are then presented to the end user.

Since each is in the business of making money, the output must be more valuable than the process of creating it.

Manufacturing companies create value by turning raw materials into products that the population can use and benefit from.

Retailers create value by taking the product and packaging it in a way that is convenient for customers.

This may be physical packaging or, in the case of an insurance company, the way the product is presented or where it is sold.

Insurance companies offer insurance to individuals at an affordable price, but to do so, they must secure their own insurance with a larger provider that is better equipped to underwrite the policy.

If a private citizen was required to take out one of these re-insurance policies themselves, the cost would be prohibitively high.

By facilitating a much cheaper policy, the insurance company adds value to the chain and makes money in the process.

Understanding supply chains

Supply chains, instead, illustrate the connection between various companies, activities, and functions involved in transforming raw materials into a product that is marketed and sold to the customer.

This “journey” usually involves suppliers, manufacturers, wholesalers, distributors, and retailers – though the order may be different in some contexts while others will omit certain entities completely.

Supply chains are controlled by a cross-functional system known as supply chain management, which may include product development, integration, information sharing, procurement, distribution, customer service, and performance analysis.

While the idea of value chains arose from business management, supply chains have their roots in operational management since they are more concerned with product conveyance.

In other words, they exist to ensure that raw materials are turned into end products that can actually reach the customer. 

Supply chains and value chains

Despite the differences between each idea, both are integral parts of efficient global logistics.

Supply chains operate 24/7 and ensure that cobalt mined in the Democratic Republic of Congo can be incorporated into the battery of a smartphone sold in San Francisco. 

Value chains motivate or incentivize the various supply chain entities to provide value at different stages as raw materials are turned into useable products.

over value adding and work to ensure customers can conveniently access products.

The primary activities of Porter’s Value Chain model

Porter breaks down his value chain model into five primary processes or activities.

1. Inbound logistics

This includes the warehousing and associated inventory control of raw materials. This also includes the nature of the relationship with suppliers.

2. Operations

Operations encompass any process that turns raw materials into a finished product ready for sale, including labeling, branding, and packaging.

3. Outbound logistics

Outbound logistics concern any process where the product is distributed to a customer. This includes the storage and distribution of products and the processes involved in fulfilling customer orders.

4. Marketing and sales

Any processes that attempt to enhance product visibility among a target audience are included in marketing and sales. This activity is also heavily reliant on customer relationships.

5. Services

Services include any processes that occur after a purchase has been made, including customer service, repairs, refunds, and warranty acknowledgment.

Secondary activities

Within Porter’s Value Chain model four secondary activities support the foundational primary activities common to most businesses.

Here is a brief look at each.

1. Company infrastructure

Company infrastructure entails any process that supports daily business operations. Administration, clerical, financial, and line management are all value-creating infrastructure processes.

2. Human resource management

Human resource management (HRM) covers any process related to the training, acquisition, or termination of employees. HRM departments and their ability to hire talented and motivated staff are crucial to a company’s competitive advantage.

3. Research and development

Technology can create a competitive advantage in Porter’s value chain because it can streamline important processes. These include payroll automation software, customer service procedures, and distribution networks.

4. Procurement

Procurement is simply the acquisition of necessary goods or services. The most typical example is the procurement of raw materials and the negotiation of pricing and product purchase contracts. It may also include the purchase of equipment, offices, buildings, and machinery.

Starbucks and Porter’s value chain model

To better understand the value chain concept, let’s take a look at the various value chain and secondary process activities using Starbucks as an example.

Value chain activities

Inbound logistics  

The Starbucks value chain begins with buyers purchasing high-quality coffee beans from primary producers in Asia, Africa, and Latin America. The beans are roasted and packaged – which adds value to their sale price – and sent to a mixture of Starbucks-owned and third-party distribution centers.

Note that the procurement process is never outsourced to ensure quality standards are enforced from the start of the chain.

Operations

Starbucks operates more than 32,000 stores in 80 different countries. Stores are either company-owned or licensed to other companies who have access to desirable retail spaces such those inside airports.

Starbucks also owns a range of related brands such as La Boulange, Teavana, Ethos Water, and Seattle Coffee Co.

Outbound logistics

Starbucks does not tend to employ a B2B model where other brands distribute its products, but a small selection of coffee products can be found in supermarkets. 

Most products are transported from warehouses and distribution centers and then sold in Starbucks stores and cafés around the world. 

Marketing and sales

Starbucks is one of the world’s most recognizable brands, and for good reason. The company is able to promote its brand with consistent messaging across social media, video, television, events, and various in-store experiences such as new product sampling.

Service

The company aims to build brand loyalty through a superior in-store experience. After witnessing the café culture in Italy, CEO Howard Schultz wanted to bring a similar experience to American coffee lovers. 

In a later interview, he wanted Starbucks to serve “as a third place between home and work, an extension between people’s lives, at a time when people have no place to go.” In addition to home-based comforts, Starbucks invests heavily in customer service training to add value to the chain.

Secondary process activities

Let’s now take a look at the secondary process activities.

Company infrastructure

This encompasses various departments that are necessary to maintain company operations, such as finance and legal. 

Starbucks also employs business managers in corporate offices and store managers in each café to oversee the baristas.

Human resource management

Starbucks is well known for its effective human resource management. Employees are offered a range of perks, including health coverage, paid leave, retirement plans, subsidized university education, company stock plans, and discounts on work-related transportation expenses. 

These initiatives result in a motivated, efficient, and engaged workforce which increases employee retention.

Research and development

Each Starbucks store provides unlimited bandwidth free of charge which creates significant value for casual diners and businessmen alike. The company also uses technology to ensure the taste of its coffee is consistent across its stores.

The Starbucks Rewards program app is another example of the café chain using technology to its advantage. Customers can download an app, use it to pay for their coffee, and collect stars that can be redeemed for food, drinks, and more. Customers must preload the app with money or redeem a gift card to make a purchase.

Procurement

As we noted earlier, procurement for Starbucks means sourcing coffee beans directly from primary producers on several continents. Purchasing agents that are employed by the company form strategic partnerships with each producer and communicate the standards they must meet in terms of bean quality.

Amazon Value Chain model Example

Now will repeat the value chain analysis, this time for eCommerce behemoth Amazon.

Value chain activities

Inbound logistics  

In general terms, Amazon does not source raw materials from suppliers because it does not manufacture its own products. As a primarily online retail business, the Fulfillment by Amazon (FBA) service allows sellers to have their items picked, packed and shipped by the company in one of its many fulfillment centers around the world.

Value is added via immense economies of scale and additional perks such as free shipping and access to buyer traffic. The company also takes care of customer service and product returns as part of the FBA service.

Operations

Amazon’s operations are divided into three core segments:

  1. North America – which includes websites in the United States, Canada, and Mexico.
  2. International – which includes country-specific websites in a further 13 locations such as Australia, China, France, Germany, and Spain.
  3. Amazon Web Services (AWS) – incorporating sales of cloud infrastructure services, storage and database items, plus other services for enterprises, governments, and academic institutions.

Outbound logistics

Amazon utilizes approximately 185 fulfillment centers around the world as part of its FBA service. Product fulfillment is supported by robotic inventory technology and then delivered via aircraft, ships, trucks, drones, and local couriers.

Outbound logistics also encompasses the delivery of downloadable products and physical store sales such as those from the Whole Foods Market chain.

Marketing and sales

Amazon spends billions of dollars on marketing each year across online and offline channels. The company promotes its vast selection of products and services, rapid delivery, superior customer service, and membership programs such as Amazon Prime.

Services

Amazon offers customers unprecedented levels of customer service for buyers in terms of shipping, refunds, returns, and exchanges. It also works with vendors to ensure warranties and other promises are honored when applicable.

Vendors are also offered a suite of business tools that increase their odds of success. This includes training and documentation on advertising products, setting competitive prices, and earning exemplary customer reviews.

Secondary process activities

Company infrastructure

A company of Amazon’s size would not be viable for long without the necessary infrastructure in place. The company has an extremely consistent, reliable, and scalable logistics system. What’s more, it has managed to turn some parts of its infrastructure into businesses in its own right. One example is the cloud-based Amazon Web services.

Human resource management

Amazon utilizes a mixture of employees, contractors, and seasonal or temporary labor to cope with periods of increased consumer demand. Employee performance is assessed with a lean, data-driven, Six Sigma-Esque approach instituted by CEO Jeff Bezos.

In the United States, Amazon’s minimum wage of $18 per hour is twice the federally mandated rate. The company also offers benefits that extend to an employee’s immediate family, such as paid parental leave, retirement plans, and healthcare coverage.

Research and development

Amazon has utilized technology to its advantage, whether that be drone deliveries and robotic warehouses or via acquisitions of virtual and augmented reality companies such as Oculus.

In 2020, the company’s SEC filing noted it was granted 2,244 patents. The majority of these were in machine learning, artificial intelligence, computer vision.

Procurement

Amazon procurement is formally known as Sales and Operations (S&OP). The company forecasts individual product sales and monitors real-time inventory levels based on receipts and shipments from fulfillment centers. 

Procurement also includes the necessary equipment, resources, technology, and infrastructure required for its core eCommerce platform. Also included here is vendor and supplier procurement, which encompasses information systems, supply chain partner eligibility rules, and performance evaluation.

Apple Value Chain Model Example

In the third example, let’s discuss Apple’s value chain.

Value chain activities

Inbound logistics

Apple is known, among other things, for its superior supply chain management and mostly relies on overseas manufacturers for components. For example, components for the iPhone are sourced from 43 countries on six continents before assembly in a factory and distribution to warehouses and retailers.

The company has a lot of leverage when dealing with suppliers because of its financial clout. It sets stringent quality standards and finds innovative ways to decrease its storage costs. 

Operations

Operations are divided into five market segments: America, Europe, Greater China, Japan, and Rest of Asia Pacific. Manufacturing is concentrated in Asia where labor is more affordable.

Outbound logistics

Assembled Apple products are sent to intermediate warehouse facilities where they are then made available to online stores, retail stores, sales teams, wholesalers, retailers, and cell network carriers. 

Marketing and sales

While most Apple products tend to sell themselves, the company nevertheless spends millions on marketing its brand. It promotes its technological products with simple sales copy and has promoted a brand that is cool, fun, and friendly.

Apple tends to avoid traditional forms of advertising such as PPC, instead of relying on positive reviews from news media and celebrity product endorsements.

Services

Apple maintains strong customer service across the pre-purchase, purchase, and post-purchase periods. Service staff in Apple stores embody the brand and are polite, helpful, and knowledgeable about the product range.

The vast majority of Apple software and hardware products include 90 days of free support.

Secondary process activities

Now for Apple’s secondary process activities.

Company infrastructure

The company is supported by a hierarchical organizational structure with product-based divisions and some degree of inter-divisional collaboration. 

Apple has become less hierarchical and more collaborative over the years in a shift that was precipitated by CEO Tim Cook.

Human resource management

Apple’s human resource management focuses on maximizing the returns (and minimizing the risks) of human capital. HR is responsible for leadership development, incentive compensation, employee development, employee relations, and recruitment and selection.

Apple has a rigorous recruitment process that consists of initial screening sessions, up to five FaceTime interviews, assessment center exercises, and onsite interviews that may last for up to six hours. This competitive process ensures the company hires the best talent.

Research and development

Apple is synonymous with research and development, spending $21.91 billion on innovation in the 2021 fiscal year.

Many company innovations have changed the world, including the Mac, iPhone, iPod, and Apple Watch. Apple is also invested in the self-driving car, sustainable energy, and healthcare industries.

Procurement

Apple has a robust supplier ecosystem that helps the company obtain high-quality products and services. Importantly, these products and services are delivered promptly and at a price that represents the best possible value to customers and shareholders.

Procurement is underpinned by fair and equal treatment of suppliers. There is also a core focus on supplier diversity, which means Apple does business with companies that are owned by women, LGBTQ+ individuals, minorities, and those with a disability.

Tesla Value Chain Model Example

Here is another example of Porter’s value chain. This time, we’ll analyze the chain in terms of electric vehicle manufacturer Tesla.

Primary activities

Inbound logistics

To overcome the obstacles associated with sourcing batteries for its vehicle fleet, Tesla partnered with Panasonic to build the Gigafactory. This also reduced the cost of battery production. Tesla then entered into deals with Daimler and Toyota to learn more about the vehicle manufacturing process and fund their powertrain and battery technology.

Tesla stores its various raw materials and tech in multiple warehouses around the world and a principal factory in Fremont, California.

Operations

Unlike other vehicle manufacturers, Tesla vertically integrates aspects of production, packing, assembly, design, and recharging systems. With both the engineering and design teams based in Fremont, value is created from more efficient production and logistics systems.

Outbound logistics

For consumers who live within a certain radius, Tesla vehicles are delivered directly to their homes. Others are delivered to dealerships or in some cases, third-party carriers.

Marketing and sales

Complementary to Tesla’s unique direct delivery model is a multi-faceted model for vehicle sales comprising online stores and Apple-esque retail outlets. The latter are typically found in large cities where brand exposure can be maximized.

The company also relies on the public persona of Elon Musk for much of its marketing returns. Musk’s Twitter account is never far from the headlines and his decision to purchase the social media platform may also bode well for Tesla.

Services

Tesla provides after-sales services via its dealerships and service centers. Services are also provided by a fleet of vehicles that allows the company to scale its service capability with very little capital investment.

Secondary activities

Procurement

For now, Tesla is heavily reliant on its direct suppliers of battery metals such as lithium, cobalt, and copper. The value created from inbound logistics allows Tesla to procure materials at a competitive price. 

To future drive down costs, Musk has mentioned on more than one occasion that Tesla owning and operating a lithium mine is a future possibility.

Human resource management

To some extent, Tesla relies on the value created by its enigmatic leader who is unlikely to ever leave the company or sell his vision to someone else.

However, more value is created by Tesla’s large cohort of engineering, manufacturing, marketing, sales, tech, installation, and service personnel.

Infrastructure

Tesla operates two infrastructure segments: 

  1. Automotive – including the design, manufacture, sale, and leasing of EVs.
  2. Energy Generation – which includes similar functions for solar energy systems, energy storage products, and related services and incentives.

Technological development

It goes without saying that Tesla creates massive value through technological development. The company owns proprietary powertrain systems and is a leader in lithium-ion batteries, radar sensors, autopilot control systems, and renewable energy. 

Tesla also shares car telemetry data with communications companies in the event a driver experiences a flat battery and requires assistance.

For every vehicle that is sold, Tesla spends more than any other manufacturer on research and development. In 2020 this equated to $2984 per car compared to just $1186 at Ford and $878 at General Motors.

Key takeaways:

  • Porter’s Value Chain model is a strategic management tool for the analysis of a company’s value chain.
  • Porter’s Value Chain model is customer relationship-centric and is used by businesses to systematically examine each of their many processes for profitability. It is comprised of five primary value chain activities that are further supported by four secondary process activities.
  • The value chain of Starbucks starts from the moment it sources beans from primary producers in various countries. Value is also added to the Starbucks in-store experience and consistent brand messaging.

Read Next: Amazon Business Model.

Read also: Business Strategy, Examples, Case Studies, And Tools

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